Class Notes (836,052)
Canada (509,597)
Economics (1,617)
ECON 1BB3 (535)
Lecture

Chapter 8 Summary.pdf

9 Pages
37 Views
Unlock Document

Department
Economics
Course
ECON 1BB3
Professor
Bridget O' Shaughnessy
Semester
Winter

Description
Summary of Lecture Notes from Chapter 8 and Practice Questions KEY POINTS: 1. The Canadian financial system is made up of many types of financial institutions, such as the bond market, the stock market, banks, and mutual funds. All these institutions act to direct the resources of households who want to save some of their income into the hands of households and firms who want to borrow. 2. National income accounting identities reveal some important relationships among macroeconomic variables. In particular, for a closed economy, national saving must equal investment. Financial institutions are the mechanism through which the economy matches one person’s saving with another person’s investment. 3. The interest rate is determined by the supply and demand for loanable funds. The supply of loanable funds comes from households who want to save some of their income and lend it out. The demand for loanable funds comes from households and firms who want to borrow for investment. To analyze how any policy or event affects the interest rate, one must consider how it affects the supply and demand for loanable funds. 4. National saving equals private saving plus public saving. A government budget deficit represents negative public saving and, therefore, reduces national saving and the supply of loanable funds available to finance investment. When a government budget deficit crowds out investment, it reduces the growth of productivity and GDP. I. Definition of financial system: the group of institutions in the economy that help to match one person’s saving with another person’s investment. II. Financial Institutions in the Canadian Economy A. Financial Markets 1. Definition of financial markets : financial institutions through which savers can directly provide funds to borrowers. 2. The Bond Market a. Definition of bond : a certificate of indebtedness. b. A bond identifies the date of maturity and the rate of interest that will be paid periodically until the loan matures. c. One important characteristic that determines a bond’s value is its term. The term is the length of time until the bond matures. All else equal, long-term bonds pay higher rates of interest than short-term bonds. d. Another important characteristic of a bond is its credit risk, which is the probability that the borrower will fail to pay some of the interest or principal. All else equal, the more risky a bond is, the higher its interest rate. 1 2 ☞ Chapter 8/Saving, Investment, and the Financial System e. The Canadian government is considered a relatively safe credit risk, while provincial governments and corporations are considered to be somewhat greater credit risks. Corporations tend to pay higher interest rates on their bonds compared to provincial and Government of Canada bonds. 3. The Stock Market a. Definition of stock: a claim to partial ownership in a firm. b. The sale of stock to raise money is called equity finance; the sale of bonds to raise money is called debt finance. c. Stocks are sold on organized stock exchanges (such as the New York Stock Exchange, NASDAQ, or the Toronto Stock Exchange) and the prices of stocks are determined by supply and demand. d. The price of a stock generally reflects the perception of a company’s future profitability. e. A stock index is computed as an average of a group of stock prices. B. Financial Intermediaries 1. Definition of financial intermediaries : financial institutions through which savers can indirectly provide funds to borrowers. 2. Banks a. The primary role of banks is to take in deposits from people who want to save and then lend them out to others who want to borrow. b. Banks pay depositors interest on their deposits and charge borrowers a higher rate of interest to cover the costs of running the bank and provide the bank owners with some amount of profit. c. Banks also play another important role in the economy by allowing individuals to use chequing deposits as a medium of exchange. 3. Mutual Funds a. Definition of mutual fund : an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds. b. The primary advantage of a mutual fund is that it allows individuals with small amounts of money to diversify. Chapter 8/Saving, Investment, and the Financial System ☞ 3 c. Mutual funds called “index funds” buy all of the stocks of a given stock index. These funds have generally performed better than funds with active fund managers. This may be true because they trade stocks less frequently and they do not have to pay the salaries of fund managers. III. Saving and Investment in the National Income Accounts A. Some Important Identities 1. Remember that GDP can be divided up into four components: consumption, investment, government purchases, and net exports. Y = C + I + G + NX 2. We will assume that we are dealing with a closed economy (an economy that does not engage in international trade or international borrowing and lending). This implies that GDP can now be divided into only three components: Y = C + I + G 3. To isolate investment, we can subtract C and G from both sides: Y - C - G = I 4. The left-hand side of this equation (Y – C – G) is the total income in the economy after paying for consumption and government purchases. This amount is called national saving. 5. Definition of national saving (saving): the total income in the economy that remains after paying for consumption and government purchases. 6. Substituting saving (S) into our identity gives us: S = I 4 ☞ Chapter 8/Saving, Investment, and the Financial System 7. This equation tells us that saving equals investment. 8. Let’s go back to our definition of national saving once again: S = Y - C - G 9. We can add taxes (T) and subtract taxes (T): S = (Y - C - T)
More Less

Related notes for ECON 1BB3

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit