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Lecture 5

ECON 201 Lecture 5: ECON201Week5

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ECON 201
Dennis O' Dea

Savings, Financial Markets Savings ● Part of income that isn’t spent ● Income = consumption + savings ● Y= C + S ● Rearrange: S = Y - C ● Savings is whatever is left over after consumption ● But we already know from income accounting identity that income is equal to spending ● Imagine that G=0, NX=0 ○ We are ignoring government and rest of world ● Then, Y = C + I ● Rewrite Y - C = I ● Since S = Y - C, ● S=I Too simple, add government back in ● So, Y = C + I + G ● Government collects taxes and borrows money National Savings ● Taxes reduce income available for spending and saving: ● Disposable income: ​ Y - T ● Private Savings: ​ Y - T - C ● What does the government do with T? Buys G ● So, ○ Y = C + I + G ○ Y - C - G = I ○ Y - T -C + T - G = I ○ (Y - T - C) + (T - G) = I ○ Private Saving + Public Savings = Investment ○ National Savings = Private Saving + Public Saving ● Let’s add back in the rest of the world ● Y = C + I + G + NX ● Private S + Public S = I + NX ● National Saving = I + NX ● NX can be positive or negative: ○ If NX is negative, then National Savings < 1 ○ If NX is positive, then National Savings > 1 ■ This means our savings are leaving the country, financing investments elsewhere Matching up Savings and Investment Spending ● Savings-investment spending identity: savings and investment spending are always equal for the economy ● Budget surplus: difference between tax revenue and government spending when taxes revenue exceeds government spending ● Budget deficit: difference between tax revenue and government spending when government spending exceeds tax revenue ● Budget balance: difference between tax revenue and government spending ● National savings: sum of private spending and budget balance, total amount of savings generated within the economy ● Capital inflow is the net inflow of funds into a country Different Kinds of Capital ● Physical Capital: manufactured resources ● Human Capital: ● Financial Capital: The Market for Loanable Funds ● Loanable funds market: hypothetical market that examines the market outcomes of the demand for funds generated by borrowers and the supply of funds provided by lenders ● Interest Rate: price, calculated as a percentage of the amount borrowed, charged by the lender to a borrower for the use of their savings for one year ● Rate of Return: profit earned on the project expressed as a percentage of its cost ○ Rate of return =( (revenue from project - cost of project)/ Cost of project ) x100 ○ If the return is too low, you are better off sticking your money in a bank and earning interest of the Demand for Loanable Funds ● Factors that can cause the demand curve to shift include: ○ Changes in perceived business opportunities ○ Changes in the government’s borrowing ● Crowding out occurs when a government deficit Shifts of the Supply for Loanable Funds ● Factors that can cause the supply of loanable funds to shift include ○ Changes in private savings behavior ○ Changes in capital inflows Inflation and Interest Rates ● Most important factor affecting interest rates over time is changing expectations about future inflation ● Shifts both supply and demand for loanable funds The Fisher Effect ● Fisher Effect: increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged ------------------ The Financial S
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