AP Economics
Mr. Bernstein
Module 22:
Saving, Investment and the Financial
System
February 2016
AP Economics
Mr. Bernstein
Saving, Investment and the Financial System
• Objectives - Understand each of the following:
• The relationship between savings and investment
spending
• The purpose of the four principal types of financial assets:
stocks, bonds, loans and bank deposits
• How financial intermediaries help investors achieve
diversification and help firms source funding of physical
capital
2
AP Economics
Mr. Bernstein
The Savings-Investment Spending Identity
• Assume a simple economy – no G, no Xn
• Total Income = Total Spending
• All money spent winds up in
another’s pocket as income
• Total Income = Consumption + Savings
• Total Spending = Consumption + Investment
• So C + S = C + I…and S = I
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AP Economics
Mr. Bernstein
The Savings-Investment Spending Identity, cont.
• Adding in Government
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•
•
•
Budget Balance (BB) = Tax revenue – G – Transfers
BB > 0 is a surplus, BB < 0 is a deficit
Now we have S + BB = I
Notice is BB is a deficit, I must decrease
4
AP Economics
Mr. Bernstein
The Savings-Investment Spending Identity, cont.
• Adding in Capital Inflows/Outflows
• Investors can save in home country or overseas
• Capital Inflow (CI) is foreign savings coming into the USA
minus US savings flowing out
• Now we have S + BB + CI = I
• Notice when CI > 0, I must increase
5
AP Economics
Mr. Bernstein
Three Tasks of a Financial System
• Reducing Transactions Costs
• Making it easier and less costly to engage in borrowing
or other financial transactions
• Reducing Risk
• Reducing Financial Risk – ie sharing ownership
• Diversification – investing in assets with unrelated risks
• Providing Liquidity
• Ease of turning asset into cash
• Done via loans, stocks, bonds
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AP Economics
Mr. Bernstein
Key Financial System Terms
• Wealth = accumulated savings
• Financial Asset = Paper Claim to future income
• Loans: Lending agreement between borrower and lender
• Bonds: Promise by seller to pay fixed amount of
payments plus all principal on maturity date
• Loan-Backed Securities: Pool of loans “securitized”
• Stocks: Slices or “shares” of ownership
• Physical Assets
• Liabilities
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