Chapter230.pdf

5 Pages
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Department
Management and Organizational Studies
Course Code
Management and Organizational Studies 2275A/B
Professor
Henry Meredith

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Description
Chapter 23 Finance, Saving, and Investment Financial Institutions and Financial Markets • Saving is the source of funds that are used to finance investment. • Financing investment is crucial because investment in new capital makes the economy grow. • These funds are supplied and demanded in three types of markets: loan markets, bond markets, and stock markets. • Physical capital is the tools, instruments, machines, buildings, and other items that have been produced in the past and that are used today to produce goods and services. The funds that firms use to buy physical capital are called financial capital. • A financial institution is a firm that operates on both sides of the market for financial capital. • The key Canadian financial institutions are banks, trust and loan companies, credit unions and caisses populaires, pension funds, and insurance companies. The Market for Loanable Funds • How investment is financed: o Y = C + S + T (households use their income to buy consumption goods, save, and pay taxes) o Y = C + I + G + NX o So, S + T = I + G + NX o And, I = S + T - G - NX o S is household (private) saving o T - G is government saving (or dissaving) o -NX is foreign saving o The sum of private saving (S) and government saving (NT – G) is called national saving. • The nominal interest rate is the number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed or lent. • The real interest rate is the nominal interest rate adjusted to remove the effects of inflation on the buying power of money. The real interest rate is approximately equal to the nominal interest rate minus the inflation rate. • The real interest rate is the opportunity cost of loanable funds. • The quantity of loanable funds demanded is the total quantity of funds demanded to finance investment, the government budget deficit, and international investment or lending during a given period. • The figure below shows the demand for loanable funds curve. • Other things remaining the same, the higher the real interest rate, the smaller is the quantity of loanable funds demanded; and the lower the real interest rate, the greater is the quantity of loanable funds demanded. • When expected profit from new capital increases during an expansion, the greater is the amount of investment and the greater the demand for loanable funds. The demand for loanable funds curve shifts rightward. • The quantity of loanable funds supplied is the total funds available from private saving, a government budget surplus, and international borrowing during a given period. • The figure below shows the supply of loanable funds curve. • Other things remaining the same, the higher the real interest rate, the greater is the quantity of loanable funds supplied; and the lower the real interest rate, the smaller is the quantity of loanable funds supplied. • The supply of loanable funds increases a
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