Chapter 8 Notes FULL lecture notes for Chapter 8

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Published on 16 Oct 2011
School
University of Waterloo
Department
Economics
Course
ECON102
Page:
of 9
Econ 102 Chapter 8 Notes Prof: Angela Trimarchi
Chapter 8: Saving and Investment
Recall:
Income Expenditure Identity
GDP = Y
= C + I + G + (X - M)
Assume that X=M, then:
GDP = Y
= C + I + G
Closed economy: one that does not trade and doesn’t have external links
with the rest of the world
We can rearrange the above equation to solve for I:
I = Y - C - G
We can subtract and add government taxes, T, to the right hand side of the
above equation:
I = Y – C – T – G + T
= (Y – C – T) + (T – G)
Therefore, the two main terms are the following:
(Y - C - T) = private saving
(T - G) = public saving
Therefore:
I = private saving + public saving
Government Budget
Recall:
(T – G) = public saving / government budget
T – Tax revenue
G – Government spending
If T - G > 0, then there is a budget surplus and public saving.
If: T – G < 0, then there is a budget deficit and public dis-saving.
Recall Expression for I once again:
I = Y - C - G
Y – C – G is also equal to national savings, symbol for national savings is S
Financial Markets
Bond Market
Stock Market
Econ 102 Chapter 8 Notes Prof: Angela Trimarchi
Bond Market
What is a bond?
is a certificate of indebtedness (like an IOU) which
identifies:
othe amount of debt (principal)
owhen debt will be repaid (maturity)
orate of interest
Interest rate on a ‘new’ bond depends on the:
olength of maturity
ocredit risk
Next we will look at:
Future Value of a Bond
Present Value of a Bond
Compound Interest
Discounting
Future Value
Which would you rather have?
\$100 today? \$100 invested at 5%
for one year
= \$105 next year
Future Value
FV(j) = PV*[1 + R]j
FV : Future Value
(j) : number of compounding periods
: number of years into the future
PV : present value
R : nominal interest rate
Example:
Calculate the future value of \$100 invested at 5% for 14 years.
FV (14) = (100)*(1+0.05)14
= \$197.99
Discounting
Process of calculating the present value of a payment from a future
value.
The future value discounted by [1+R]j
\$100 \$197.99
Econ 102 Chapter 8 Notes Prof: Angela Trimarchi
Time 0 Future Time
Present Value
PV = FV(j) = FV(j) * [1+R]-j
[1+R]j
This is derived from rearranging the formula for future value.
Example:
Calculate the present value of \$100 invested at 5% interest for 1 year.
PV = \$100 / [1 + 0.05]1
= \$100 / [1.05]
= \$95.24
Calculation of j
j = ln FV
PV
ln (1 + R)
Calculation of R
R = FV 1/j
PV - 1
Question: What other formula did you learn in chapter 7 that is similar to the
formula for R? Growth Rate
Present Value of a Bond
The most someone would be willing to pay now to own the bond’s
future stream of payments
Also called the purchase price of a bond
Coupon Payment (C)
Contractual rate of interest paid on the face value of the bond
Term originated many years ago when it was customary for the bond
certificate to have interest coupons attached to its margin
At each interest payment date, the bond holder would clip off the
matured coupon and present it to the bank to receive payment in cash
Today most bonds are registered in the owner’s name and interest
payments are made by cheques sent through the mail
Present Value of a Bond =
C/[1+R]1 + C/[1+R]2 + … + C/[1+R]n + PRINC/[1+R]n
j = n
j is the number of compounding periods
PRINC = principal
Question: What is another name for the present value of a bond? Purchase

Document Summary

= c + i + g + (x - m) Closed economy: one that does not trade and doesn"t have external links with the rest of the world. We can rearrange the above equation to solve for i: We can subtract and add government taxes, t, to the right hand side of the above equation: I = y c t g + t. = (y c t) + (t g) Therefore, the two main terms are the following: (y - c - t) = private saving (t - g) = public saving. Recall: (t g) = public saving / government budget. If t - g > 0, then there is a budget surplus and public saving. If: t g < 0, then there is a budget deficit and public dis-saving. Y c g is also equal to national savings, symbol for national savings is s.