macroexam

Savings–Investment Identity (Closed Economy)

National saving equals investment

Savings–Investment Identity (Open Economy)

Investment equals national saving plus net capital inflow

Present Value

Current value of a future payment

Future Value

Value of money after earning interest

Financial System

Institutions that allocate savings to investment

Financial System Functions

Reduce transaction costs, reduce risk, provide liquidity

Transaction Costs

Costs of making an exchange

Risk

Uncertainty of outcomes

Risk Sharing

Reducing individual risk through pooling

Diversification

Investing across assets to reduce risk

Liquidity

Ease of converting assets to cash

Illiquid Asset

Asset difficult to convert to cash

Nominal Interest Rate

Interest rate without inflation adjustment

Real Interest Rate

Nominal rate minus inflation

Inflation

Increase in overall price level

Fisher Equation

Nominal rate equals real rate plus inflation

Stock

Ownership share in a firm

Bond

Loan to a borrower

Dividend

Payment made to stockholders

Capital Gain

Increase in asset value

Mutual Fund

Pool of investor funds in diversified assets

Index Fund

Mutual fund tracking a market index

Arbitrage

Profiting from price differences

Efficient Markets Hypothesis

Prices reflect all available information

Speculation

Buying assets expecting price increases

Asset Bubble

Prices exceed fundamental value

Safe Asset

Asset with low default risk

Risky Asset

Asset with uncertain returns

Default Risk

Risk borrower fails to repay

Inflation Risk

Risk inflation erodes purchasing power

Portfolio

Collection of financial assets

Financial Intermediary

Institution connecting savers and borrowers

Bank

Accepts deposits and makes loans

Bond Market

Market for buying and selling bonds

Stock Market

Market for buying and selling stocks

National Saving

Income minus consumption and government purchases

Private Saving

Income minus consumption and taxes

Public Saving

Tax revenue minus government spending

Budget Surplus

Revenue exceeds government spending

Budget Deficit

Government spending exceeds revenue

Loanable Funds Market

Market for savings and investment

Supply of Loanable Funds

Determined by saving

Demand for Loanable Funds

Determined by investment

Equilibrium Interest Rate

Supply equals demand for loanable funds

Crowding Out

Government borrowing reduces private investment

Net Capital Outflow

Domestic investment abroad minus foreign investment

Net Capital Inflow

Foreign investment minus domestic investment abroad

Open Economy

Economy engaged in international trade

Closed Economy

Economy without international trade

Capital Flight

Large movement of capital out of a country

Investment Spending

Spending on capital equipment and structures

Consumption

Household spending on goods and services

Government Purchases

Government spending on goods and services

Disposable Income

Income after taxes

Saving

Income not spent on consumption

Real GDP

GDP adjusted for inflation

Nominal GDP

GDP measured at current prices

Wealth

Value of assets owned