Chapter 19 - Saving, capital formation & financial markets
Saving and wealth
- Saving: current income minus spending on current needs.
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- Saving rate: saving divided by income.
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- Wealth: value of assets minus liabilities.
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- Assets: anything of value that one owns.
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- Liabilities: debts one owes.
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- Balance sheet: list of an economic unit's assets and liabilities on a specific a date.
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- Flow: measure that is defined per unit of time.
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- Stock: measure that is defined at a point in time.
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- Capital gains: increases in the value of existing assets.
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- Capital losses: decreases in the value of existing assets.
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National saving and its components
- National saving: saving of the entire economy, equal to GDP less consumption expenditures and government purchases of goods and services, or Y - C - G.
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- Transfer payments: payments the government makes to the public for which it receives no current goods/services in return.
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- Private saving: saving of the private sector of the economy is equal to the after-tax income of the private sector minus consumption expenditures (Y - T - C) * It can be further broken down into household saving and business saving.
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- Public saving: saving of the government sector is equal to net tax payments minus government purchases (T - G).
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- Government budget surplus: excess of government tax collections over government spending (T - G) * It equals public saving.
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- Government budget deficit: excess of government spending over tax collections (G - T).
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Why do people save?
- Life-cycle saving: saving to meet long-term objectives such as retirement, college attendance, or the purchase of a home.
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- Precautionary saving: saving for protection against unexpected setbacks such as the loss of a job or a medical emergency.
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- Bequest saving: saving done for the purpose of leaving an inheritance.
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Investment and capital formation
- Any of the following factors will increase the willingness of firms to invest in new capital: * Decline in the price of new capital goods * Decline in the real interest rate * Technological improvement that raises the marginal product of capital * Lower taxes on the revenues generated by capital * Higher relative price for the firm's output
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Bonds, stocks and the allocation of savings
- Bond: legal promise to repay a debt, usually including both the principal amount and regular interest, or coupon, payments.
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- Principal amount: amount originally lent.
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- Maturation date: date at which the principal of a bond will be repaid.
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- Coupon payments: regular interest payments made to the bondholder.
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- Coupon rate: interest rate promised when a bond is issued; the annual coupon payments are equal to the coupon rate times the principal amount of the bond.
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- Stock (or equity): claim to partial ownership of a firm.
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- Dividend: regular payment received by stockholders for each share that they own.
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- Risk premium: rate of return that financial investors require to hold risky assets minus the rate of return on safe assets.
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- Diversification: practice of spreading one's wealth over a variety of different financial investments to reduce overall risk.
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- Mutual fund: financial intermediary that sells shares in itself to the public and then uses the funds raised to buy a wide variety of financial assets.
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Saving, investment and financial markets
- Any of the following factors will shift the demand for savings (I) to the right: * Decline in the price of new capital goods * Technological improvement that raises the marginal product of capital * lower taxes on the revenues generated by capital * Higher relative price for the firm's output * Supply of savings will shift right if national saving, private and/or public saving, is increased.
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