Chapter 26: Savings, Investment Spending and the Financial System – 1
A Hole in the Ground – What is the function of the financial system? What are the benefits of the system?
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Matching up Saving and Investment Spending – What is the difference between investment spending and
making an investment? How are they related? ___________________________________________________
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The Savings-Investment Identity – It is a fact that savings and investment spending are always
_______________.
In your own words, explain why savings must equal investment spending in a closed economy with no
government.
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When the government spends less than it collects, there is a budget __________________. In this case, there
is positive government ___________________. When government savings and private savings are added
together, the sum is called _____________________ savings. Since our government doesn’t usually save, it
_____________ spends, government savings is usually a ____________________ number. If the government
doesn’t save and the people do not save enough, the U.S. can rely on investment in our economy by
____________________________.
This amount – inflow of funds from foreigners minus outflow of funds to foreigners – is called
_________________ _________________. In the U.S. this number is generally positive, while in China it is
generally ______________.
Why are capital inflows a less desirable source of funds for domestic investment spending?
___________________
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There are three main types of capital in economics. In this chapter, we are dealing mainly with
________________
capital as the source of funding for the other two - _____________________ and ____________________
capital.
How does U.S. private savings compare with the rest of the world?
_____________________________________
Why? ___________________________________________________________________ How is this low rate of
savings possible?
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(FIM, p. 678) How does the accounting for ‘unsold inventory’ help make it certain that savings equals
investment?
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p. 700, problem 1. (Tip: T = total taxes collected) investment spending = ________
private savings =
_____
budget balance = ________ Relationship between 3: _________________________________ Does I = S? ____
2. I = ___________
PS = ____________
budget balance = ___________
KI = _______________
Relationship among 4: _________________________________________________________________________
3. Capsland budget balance = _______
Marsalia budget balance = _______
Which has a deficit?
__________
4. a. PS = ________ (show work here)
c. Budget balance = _________
b. I = ________
d. IM – X =________
The Market for Loanable Funds – The _______________________ markets bring savers and borrowers
together.
While there are many different financial products available that have different risks and rates of return, we
will simplify the financial markets into one market called the ___________________ ________________
market. In this market there is only one __________________ _____________ (r), represented on the y-axis.
All savings are represented on the x-axis as the ______________________ of ____________________
_______________.
Define the term ‘rate of return’ in describing why the demand for loanable funds is a downward sloping curve.
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Why is the supply of loanable funds curve upward sloping?
_____________________________________________
Which curve, S or D, represents Investment spending (I)? ____ Which curve represents Total Savings (TS)?
____
How does the loanable funds market create efficient outcomes?
_________________________________________
____________________________________ Note that firm belief in this market distinguishes western
economies. For example, China is more leery about private risk assessment by banks that may require a
government bailout.
Shifts of the Demand for Loanable Funds – Describe how each will lead to a shift in the demand curve:
Changes in perceived business opportunities:
_______________________________________________________
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Changes in government borrowing:
_______________________________________________________________
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EXTREMELY IMPORTANT POINT: When the government borrows more, which it does when it ________
spends, interest rates in the whole economy ____________. This will push the interest rates above the rates of
return on certain investment projects. This decrease in I slows the economy since I is a component of
_________.
When more G means less I, the effect is referred to as ____________________ ___________. The government,
which does not seek profit and is generally less efficient, has crowded out the growth-seeking ___________
sector.
Shifts of the Supply of Loanable Funds - Changes in private savings behavior:
____________________________
____________________________________________________________________________________________
Changes in capital inflows:
______________________________________________________________________
Inflation and Interest Rates – While S of and D for loanable funds are important in determining r, perhaps the
most important factor historically is the expected future _________________ rate. When inflation is expected
to be high, _________________ interest rates will be high. As long as inflation is expected, the __________
interest rate does not change even as the nominal interest rate does. This is known as the
____________________ effect.
Figure 26-8 shows us that r can be affected by both ________________ and
______________________________.
Chapter 26: Savings, Investment Spending and the Financial System – 2
CYU 26-1 1.a.
b.
2. _________________________________________________________________________________________
3. a. ______________________________ b. ___________________________ c. ________________________
Pr 6.a.
7. New r = ______
b.
New Q =______
c.
Any crowding out?
__________________________________
8. Diagram a & b here.
c. ________________________
__________________________
__________________________
__________________________
10. _________________________________________________________________________________________
11. a.
________________________________________________________________________________________
b. __________________________________________________________________________________________
12. _________________________________________________________________________________________
The Financial System – Define the following terms and put them in context in the financial system.
Wealth _____________________________________________________________________________________
Financial asset _______________________________________________________________________________
Physical asset - _______________________________________________________________________________
Liability ____________________________________________________________________________________
Three Tasks of the Financial System – How does the financial system do each of the following:
Reduce transaction costs?
_______________________________________________________________________
Reduce risk through diversification?
______________________________________________________________
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Provide liquidity?
_____________________________________________________________________________
Types of Financial Assets – What are the advantages and disadvantages of each of the following assets?
Loans - _____________________________________________________________________________________
Bonds - _____________________________________________________________________________________
Loan-Backed Securities - _______________________________________________________________________
Stocks - _____________________________________________________________________________________
Financial Intermediaries – What service do each of the following provide, and what issue do they resolve?
Mutual Funds _______________________________________________________________________________
Pension Funds and Life Insurance Cos. - __________________________________________________________
Banks - _____________________________________________________________________________________
____________________________________________________________________________________________
CYU 26-2, 1. a-c. Fill in table ranking each asset on the measures listed.
Asset
Bank deposit w/ guaranteed interest rate
Share of highly diversified mutual fund, can be quickly sold
Share of family business, can be sold to willing buyer w/ family
approval
Tr. Costs
Risk
Liquidity
2. __________________________________________________________________________________________
Pr. 14. a. _______________ b. _______________ c. _______________ d. _______________ e.
_______________
Financial Fluctuations – How can fluctuations create severe short-terms stress on financial markets?
____________________________________________________________________________________________
The Demand for Stocks and Other Assets – How do each of the following affect the valuation of stocks?
Investors’ beliefs about future value ______________________________________________________________
Attractiveness of substitute assets _______________________________________________________________
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Asset Price Expectations – What is the efficient markets hypothesis, and how might it involve a random walk?
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In what ways are markets sometimes irrational? How does this detract from the efficient markets hypothesis?
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Asset Prices and Macroeconomics – Why do macroeconomists want to believe in the efficient markets
hypothesis?
____________________________________________________________________________________________
Describe the two events in recent U.S. history that support the idea that markets are often irrational and
macro-economists should be concerned with over-valuation.
_________________________________________________
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Pr. 17. a. ____________________ b. ____________________ c. ____________________ d.
__________________
18. a.
________________________________________________________________________________________
b. ____________________ c.
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