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ECON 201 (1st half) Complete Notes

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ECON 201

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Chapter 13: Saving, Investment, and the Financial System These notes more closely follow the book but also lecture notes · Financial system: consists of the institutions that help match one person's saving with  another person's investment · When a country saves a large portion of GDP, more resources are available for capital  investments →  higher capital raises productivity and standard for living   I. Financial institutions in the U.S. economy A. Financial markets: the institutions through which a person who wants to can  directly supply funds to a person who wants to borrow 1. The bond market i. Bond: certificate of indebtedness that specifies the obligations of the  borrower to the holder (IOU) ii. Debt finance iii. Three characteristics that differentiate bonds a. Term: length of time until the bond  matures 1. Long­term bonds are riskier than short­term because  takes longer to repay principal 2. Long­term usually pay higher interest rates b. Credit risk: probability the borrower  will fail to pay some of the interest or principal (default) 1. Safe credit risk like government pay low interest rates 2. Junk bonds pay high interest rates; used by financially  unstable companies 3. Can judge risk by using various private agencies­­ex.  Standard & Poor's c. Tax treatment: the way tax laws  treat the interest earned 1. On most bonds is taxable income 2. Municipal bonds: issued by state and local government;  owners not required to pay taxes on interest; lower  interest rate than company or federal government bonds 2. The stock market i. Stock: represents ownership in a firm →  a claim to profits ii. Equity finance iii. Stock prices determined by supply and demand of stock → demand  reflects people's perception of the company's future profitability iv. Stock index: computed as an average of a group of stock prices a. Ex. Dow Jones Industrial Average B. Financial intermediaries: financial institutions through which savers can  indirectly provide funds to borrowers 1. Banks i. Primary job is to take in deposits from people who want to save and  use deposits to make loans to people who want to borrow a. Pay depositors interest on deposits  1 and charge borrowers slightly higher interest on loans ii. Facilitate purchase of goods and services by allowing people to write  checks against their deposits and to access those deposits with debit cards → act  as a medium of exchange 2. Mutual funds: institution that sells shares to public and uses  the proceeds to buy a selection (portfolio) of various types of stocks, bonds, or  both i. Value rises →  shareholder benefits; value falls →  shareholder suffers loss ii. Advantage: allow people with small amounts of money to diversify  their holdings a. People who have diverse portfolio  face less risk  because they have a small stake in each company iii. Advantage:  give ordinary people access to professional money  managers   II. Saving and investment in the national income accounts    GDP equation Y=C+I+G+NX Y­ GDP (income) C­consumption I­investment G­government purchases NX­net exports Closed economy­­no outside interaction (no NX) Y­C=I+G →Y­C­G=I→S=I                S=Y­C­G=national saving   A. Saving 1.National saving (saving): total income in the economy that remains after  paying for consumption and government purposes i. S=Y­C­G 2.Private saving: amount of income that households have left after paying  taxes and for consumption i. Y­T­C 3.Public saving: amount of tax revenue government has left after paying for  spending i. T­G i. If T > G, gov't has budget surplus a. T­G=positive # i. IF T 
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