FINANCE, SAVING, AND INVESTMENT

Flashcards covering key vocabulary from the lecture on Finance, Saving, and Investment in Macroeconomics Thirteenth Edition by Parkin.

Finance

The study of how households and firms obtain and use financial resources and how they cope with the risks that arise in this activity.

Money

The study of how households and firms use it, how much of it they hold, how banks create and manage it, and how its quantity influences the economy.

Capital (Physical Capital)

The tools, instruments, machines, buildings, and other items that have been produced in the past and that are used today to produce goods and services.

Financial Capital

The funds that firms use to buy physical capital.

Gross Investment

The total amount spent on purchases of new capital and on replacing depreciated capital.

Depreciation

The decrease in the quantity of capital that results from wear and tear and obsolescence.

Net Investment

The change in the quantity of capital, calculated as Gross investment minus Depreciation.

Wealth

The value of all the things that people own.

Saving

The amount of income that is not paid in taxes or spent on consumption goods and services, which increases wealth.

Capital Gains

An increase in wealth that occurs when the market value of assets rises.

Capital Losses

A decrease in wealth that occurs when the market value of assets falls.

Financial Capital Markets

Markets where funds used to finance investment are supplied and demanded, including loan markets, bond markets, and stock markets.

Financial Institution

A firm that operates on both sides of the markets for financial capital, acting as both a borrower and a lender.

Key Financial Institutions

Commercial banks, government-sponsored mortgage lenders, mutual funds, pension funds, insurance companies, and The Federal Reserve.

Sources of Funds for Investment

Household saving, government budget surplus, and borrowing from the rest of the world.

Time Value of Money

The concept used to compare current and future dollars by converting future dollars (future value) to current dollars (present value).

Present Value

The current value of a future amount, calculated as the Future amount divided by (1 + r)n when r is the interest rate and n is the number of years.

Net Present Value

The present value of all the future flows of money that arise from a financial decision minus the initial cost of the decision.

Financial Decision Rule (basic)

If the net present value is positive, do it; if negative, don't do it (when future money flows are not risky).

Net Worth (Financial Institution)

The total market value of what a financial institution has lent minus the market value of what it has borrowed.

Solvent (Financial Institution)

A financial institution is solvent if its net worth is positive, allowing it to remain in business.

Insolvent (Financial Institution)

A financial institution is insolvent if its net worth is negative, causing it to go out of business.

Market Risk

Risks associated with fluctuations in interest rates and asset prices.

Nominal Interest Rate

The number of dollars a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent.

Real Interest Rate

The nominal interest rate adjusted to remove the effects of inflation on the buying power of money, approximately equal to the nominal interest rate minus the inflation rate.

Market for Loanable Funds

The aggregate of all individual financial markets that determines the real interest rate, the quantity of funds loaned, saving, and investment.

Demand for Loanable Funds

The relationship between the quantity of loanable funds demanded and the real interest rate, influenced by the real interest rate and expected profit.

Supply of Loanable Funds

The relationship between the quantity of loanable funds supplied and the real interest rate, influenced by the real interest rate, disposable income, expected future income, wealth, and default risk.

Equilibrium in the Loanable Funds Market

Achieved at the real interest rate where the quantity of loanable funds demanded equals the quantity of loanable funds supplied.

Government Budget Surplus (Impact)

Increases the supply of funds in the loanable funds market, leading to a fall in the real interest rate and an increase in investment.

Government Budget Deficit (Impact)

Increases the demand for funds in the loanable funds market, leading to a rise in the real interest rate and a decrease in investment (crowding out).

Crowding Out

A decrease in investment that results from a government budget deficit increasing the demand for funds and raising the real interest rate.

Ricardo-Barro Effect

The theory that a budget deficit increases the demand for funds, but rational taxpayers increase saving, which increases the supply of funds, thereby financing the deficit and avoiding crowding out.