ECON 201 Module 5

finance

how households/firms obtain/use financial resources and how they cope with the associated risk

3 kinds of financial markets

loan markets, stock markets, bond markets

loan markets

a financial market in which banks loans are used to buy manufacturing equipment

stock markets

a financial market in which firms issue new shares to raise funds to build new facilities

bond markets

a financial market in which bonds are issued to finance warehouse construction

net worth equation

total market value - market value of what’s been borrowed

bond

a fixed-income investment that represents a loan made by an investor to a borrower

solvent

positive net worth, business can continue running

insolvent

negative net worth, must go out of business

present value equation

PV = future value at period n / (1+r)^n

net present value equation

NPV = payoff/(1+r)^t

present value

how much extra money you need to be paid if someone borrows your money

households

suppliers of loanable funds

loanable funds market

sum of all financial markets

private savings equation

Y - T - C

disposable income

Y - T

government savings

T - G

trade balance

X - M

current account balance

broad measure of trade balance, includes trade of goods/services and international flows of income/foreign aid

unilateral transfers

payments made abroad without receiving any direct good/service (ex. sending money to family)

financial capital

international flow of money that facilitates investment

if firms expect higher profits in the future, they invest

more

if households expect higher income, they save

less

if lenders perceive greater default risk, they save

more

if the government cuts taxes WITH Ricardian Equivalence, households save

more

if the government cuts taxes WITHOUT Ricardian Equivalence, households save

the same

if economic policies make the future uncertain, investment

decreases

if economic policies make the future uncertain, savings

increase

crowd-out effect

increased government spending and borrowing can reduce or completely offset private sector investment and consumption

trade deficit

M - X

national savings equation

S + (M - X) = I + (G - T)

Ricardian Equivalence

theory that rational private households might save more when tax cuts occur, anticipating higher taxes in the future

private savings with trade

Sp = I + (X - M) - Sg