• Financial system- the group of institutions in the economy that helps to match one person’s saving with another person’s investment

13.1: Financial Institutions in the U.S. Economy

Financial Markets:

• Financial Markets- Financial institutions through which savers can directly provide funds to borrowers

• The two most important markets are the bond market and the stock market

  • Bond- a certificate of indebtedness

  • Stock- a claim to partial ownership in a firm

Financial Intermediaries:

• Financial Intermediaries- Financial institutions through which savers can indirectly provide funds to borrowers

• Two important financial intermediaries are the banks and mutuals funds

  • Banks- pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans

    • take in deposits from people who want to save and use these deposits to make loans to people who want to borrow

  • Mutual Funds- an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds

13.2: Saving and Investment in the National Income Accounts

Some Important Identities:

• National saving- the total income in the economy that remains after paying for consumption and government purchases

• Private saving- the income that households have left after paying for taxes and consumption

• Public saving- the tax revenue that the government has left after paying for its spending

• Budget surplus- an excess of tax revenue over government spending

• Budget deficit- a shortfall of tax revenue from government spending

13.3: The Market for Loanable Funds

• The market for loanable funds- the market in which those who want to save supply funds and those who want to borrow to invest demand funds

Supply and Demand for Loanable Funds:

• Loanable funds- comes from people who have some extra income they want to save and lend out

  • Saving is the source of the supply of loanable funds

  • Investment is the source of the demand for loanable funds

Policy 1: Saving Incentives:

• If a reform of the tax laws encouraged greater saving, the result would be lower interest rates and greater investment.

Policy 2: Investment Incentives:

• If a reform of the tax laws encourages greater investment, the result would be higher interest rates and greater savings.

Policy 3: Government Budget Deficits and Surpluses

• Crowding out a decrease in investment that results from government borrowing

• a budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment