Lecture 10 ch 10

Financial Markets: Markets where financial securities, such as stocks and bonds, are bought and sold.
Financial System: Comprises financial markets and financial intermediaries through which firms acquire funds from households.
- Firms' Financing: Firms can finance some operational activities from retained earnings, which are profits that are reinvested in the firm rather than paid to the owners. This is essential for economic growth as it enables firms to:
- Expand operations
- Purchase additional equipment
- Train workers
- Adopt new technologies
Financial Securities: Documents, sometimes in electronic form, that state the terms under which funds pass from the buyer (provider) to the seller.
- Stocks: Financial securities representing partial ownership of a firm.
- Bonds: Financial securities representing promises to repay a fixed amount of funds.

Definition: Firms such as banks, mutual funds, pension funds, and insurance companies that borrow funds from savers and lend them to borrowers.
- Mutual Funds: Sell shares to savers and then buy a diversified portfolio of financial securities, including stocks, bonds, and mortgages.

Risk Sharing: Allows savers to spread their investment across many securities to mitigate the risk of individual investments.
Liquidity: Refers to the ease with which a financial security can be converted into cash. The financial system provides liquidity by offering markets where securities can be sold.
Information Collection and Communication: The financial system gathers and disseminates information regarding borrowers and expected returns on financial securities.

National Income Accounting: Used to understand the relationship between different economic variables, primarily for calculating GDP (Y). The components are:
- C: Consumption
- I: Investment
- G: Government purchases
- NX: Net exports
Equation:
- $Y = C + I + G + NX$
- In a closed economy (no international trade), net exports (NX) equals zero, simplifying the equation:
- $Y = C + I + G$
- Rearranging gives investment in terms of other variables:
- $I = Y - C - G$

Private Saving (SPrivate):
- $SPrivate = Y + TR - C - T$
- Where:
  - TR: Transfer payments
  - C: Consumption
  - T: Taxes
Public Saving (SPublic):
- $SPublic = T - G - TR$
Total Saving (S): This equals the sum of private and public saving:
- $S = SPrivate + SPublic$
- Simplifying gives:
- $S = (Y + TR - C - T) + (T - G - TR)$
Total saving must equal total investment (S = I):
- $S = Y - C - G$

Balanced Budget: When government spending equals tax revenues.
Budget Deficit: When government spending exceeds tax revenues.
- Here, T < G + TR means public saving is negative, also known as dissaving.
Budget Surplus: When government spending is less than tax revenues.

Given Data: Suppose GDP equals $10 trillion, consumption equals $6.5 trillion, government spends $2 trillion, and a budget deficit of $300 billion.
Tasks: Calculate:
- Public saving
- Taxes
- Private saving
- National saving
- Investment

Consumer Dilemma: When a consumer receives an income tax refund check:
- One roommate advises saving, citing the importance of household saving for economic growth.
- Another advises spending to boost GDP through consumer spending.
- Discussion: Evaluating which viewpoint effectively contributes to economic growth.

Market for Loanable Funds: The interaction of borrowers and lenders sets the market interest rate and determines the quantity of loanable funds exchanged.
- Assume a simplified financial market where all savers deposit their savings, and all borrowers take loans at one interest rate, acting as the return for savers and cost for borrowers.
Supply of Loanable Funds:
- Comes from saving, including:
- Households lending excess income for interest.
- Positive public saving contributing to national saving and supply of loanable funds.
- Negative public saving reduces total saving and supply of loanable funds.

Slope of the Supply Curve:
- Increasing interest rates make savings more attractive, thus increasing the quantity of loanable funds supplied.
Demand for Loanable Funds:
- Comes primarily from investment needs of firms (for equipment, factories) and households (for homes).
Slope of the Demand Curve:
- Falling interest rates lower borrowing costs, increasing the quantity of loanable funds demanded.

The equilibrium interest rate adjusts to equate supply and demand for loanable funds.
- Equilibrium quantity of loanable funds equals investment and saving supplied in the market.

Implication: Tax incentives for saving can increase the supply of loanable funds.
- Resulting in a decrease in equilibrium interest rates and an increase in equilibrium quantity of loanable funds.

Definition: A decline in private expenditures consequent to increased government purchases, affecting overall economic dynamics.

Business Cycle Definitions: Key elements:
- Peak: Highest point of economic activity
- Trough: Lowest point of economic activity
- Expansion: Phase where the economy is growing
- Recession: Phase where the economy is contracting
Graphical Representation: An idealized graph showcasing these fluctuating phases in real GDP over time.

National Bureau of Economic Research (NBER): Defines recession as a significant decline in economic activity lasting more than a few months, evident in:
- Industrial production
- Employment
- Real income
- Wholesale and retail trade
Delay in Announcement: NBER typically declares recessions well after they commence.

Managerial Considerations: Decisions needing immediate response to recession effects while preparing for subsequent economic expansion.
- Example: Intel’s $7 billion expansion in early 2009 despite economic downturn.

Graphical Representation: Figure showcasing the effect of recessions on inflation rates.

Graphical Analysis: Relationship between the unemployment rate and recessions illustrated by data visuals.

Historical Analysis: Fluctuations in real GDP were more pronounced before 1950 than in the period thereafter.

Summary: Average lengths of expansions and recessions across different time periods:
- 1870-1900: Average of 26 months for both expansions and recessions.
- 1900-1950: Expansions - 25 months, Recessions - 19 months.
- 1950-2009: Expansions - 61 months, Recessions - 11 months.
- Notable Decimation due to the 2007 recession, termed the Great Contraction.

Economists’ Perspectives: Potential explanations for the relative stability in the U.S. economy from 1950 to 2007. Discussion prompts on factors contributing to this stability.