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ECON1000 CH. 8.docx

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Carleton University
ECON 1000
Nick Rowe

Chapter 8: Saving, Investment and the Financial System In this chapter we will look for the following: •What are the main types of financial institutions in the US economy and what is their function? •What are the three kinds of saving? •Whats the difference between saving and investment? •How does the financial system coordinate saving and investment •How fo government policies affect saving, investment and the interest rate? The Financial System •Consists of the group of institions in the economy that help to match one person's saving with another person's investment •Moves the economy's scarce resources from savers to borrowers Financial Institutions in the Canadian Economy Financial markets: institutions through which savers can directly provide funds to borrowers. Examples: •The Bond Market •The Stock Market Financial Markets: The Bond Market A bond is a certificate of indebtness that specifies obligations of the borower to the holder of the bond. Characteristics of a Bond: •Term: the length of time until the bond matures •Credit Risk: the probability that the borrower will fail to pay some of the interest or principal Financial Markets: The Stock Market •Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes •The sale of stock to raise money is called equity financing o Compared to bonds, stocks offer both higher risk and potentially higher returns •The most important stock exchange in Canada is the Toronto Stock Exchange (TSX) •The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange and NASDAQ •Most newspaper stock tables provide the following information: o Price (of a share) o Volume (number of shares sold) o Dividend (profits paid to stockholders) o Price-earnings ratio •The Stock Index o Available to monitor the overall level of stock prices o Computed as an average of a group of stock prices o The best-known and closesly watched stock index in Canada is TSX 300 o The most famous stock index is the Dow Jones Industrial Average Financial Institutions Financial intermediaries: institutions through which savers can indirectly provide funds to borrowers. Examples: • Bank • Mutual funds Financial Intermediaries: Banks • Take deposits from those who save and use the deposits to make loans to those who borrow • Pay depositors interest on their deposits and charge borrowers higher interest on their loans • Help create a medium of exchange by allowing people to write checks against their deposits o A medium of exchanges is an item that people can easily use to engage in transactions o This facilitates the purchases of goods and services Financial Intermediaries: Mutual Funds A mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio of various types of stocks, bonds, or both • They allow people with small amounts of money to easily diversify Saving and Investment in the National Income Accounts Recall that GDP is both total income in an economy and total expenditure on the economy's output of goods and services: • Y + C + I + G + NX Some Important Identities Assume a closed economy, that is, one that does not engage in international trade: Y = C + I + G Now, subtract C and G from both sides of the equation Y - C - G = I The left side of the equation is the total income in the economy after paying for consumption and government purchases and is called national saving or just saving (S). Subsituting S for Y - C - G the equation can be written as: S = I National saving, or saving is equal to: S = I S = Y - C - G S = (Y - T - C) + (T - G) The Meaning of Saving and Investment National Saving • National saving is the total income in the economy that remains after payinf for consumption and government purchases Private Saving • Private saving is
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