USC ECON 205 - Savings, Investment, and the Financial System

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ECON 205 1st Edition Lecture 10 Outline of Last Lecture - How is unemployment measured?- Factors of unemployment- Efficiency wagesOutline of Current Lecture - Role of financial institutions- Savings and investment- How government policies affect saving, investment, an interest rateCurrent LectureFinancial Institutions- Financial system- group of institutions that help match savings of one person to the investment of another person- Financial markets- institutions through which savers can directly provide funds toborrowerso Stock marketo Bond market- Financial Intermediaries- institutions through which savers can indirectly provide funds to borrowerso Bankso Mutual funds- institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bondsOther Types of Savings- Private saving- portion of household’s income that is not used for consumption or taxeso = Y-T-C (income minus taxes minus consumption)- Public Saving- tax revenue minus government spendingo T-G- National Saving- private saving and public savingo (Y-T-C) + (T-G)= Y-C-G- saving is the investment in a closed economyBudget Deficits and Surpluses- Budget surplus- an excess of tax revenue over government spendingo T-G- Budget Saving- a shortfall of tax revenue from government spendingo G-To Negative public savingThe Market for Loanable Funds- A supply-demand model of the financial system- Assume there is only one financial marketo All savers deposit their saving in this marketo All borrowers take loans from this marketo There is only one interest rate, which is both the return to saving and the cost of borrowing- The supply of loanable funds comes from saving- The increase of interest rates makes saving moreattractive and increases the quantity of loanablefunds- Demand for loanable funds comes frominvestmento People take out loans to buy capital- Interest rate adjusts to equate supply anddemand- Tax incentives for saving increase the supply ofLoanable Fundso I.e. 401k- A budget deficit decreases national saving andthe supply of Loanable fundso Creates an increase in equilibrium interest ratesBudget Deficits, Crowding Out, and Long-Run Growth- Crowding out- when budget deficits reduce investmento The government borrows money and reduces the supply for other people to takeout loans- Investment is key to long-run growth- Real interest rate = nominal interest rate – inflation rateGovernment Debt- Government finances deficits by borrowing- Deficits increase during times of war- The ratio of government debt to GDP is a measure of the government’s indebtedness- Persistent deficits lead to a rising government

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