Saving, Investment

FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY
Financial Markets
Stock Market
Bond Market
Financial Intermediaries
Banks
Mutual Funds

FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY
Financial markets are the institutions through which savers can directly provide funds to borrowers.
Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.

Financial Markets
The Bond Market
A bond is a certificate of indebtedness that
specifies obligations of the borrower to
the holder of the bond.
Characteristics of a Bond
Term: The length of time until the bond matures.
Credit Risk: The probability that the borrower will fail to pay some of the interest or principal.
Tax Treatment: The way in which the tax laws treat the interest on the bond.
Municipal bonds are federal tax exempt.

Financial Markets
The Stock Market
Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes.
The sale of stock to raise money is called equity financing.
Compared to bonds, stocks offer both higher risk and potentially higher returns.
The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.(National Association of Securities Dealers Automated Quotations)

Financial Markets
The Stock Market
Most newspaper stock tables provide the following information:
Price (of a share)
Volume (number of shares sold)
Dividend (profits paid to stockholders)
Price-earnings ratio

Financial Intermediaries
Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.
Banks
take deposits from people who want to save and use the deposits to make loans to people who want to borrow.
pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

Financial Intermediaries
Banks
Banks help create a medium of exchange by allowing people to write checks against their deposits.
A medium of exchanges is an item that people can easily use to engage in transactions.
This facilitates the purchases of goods and services.
Mutual Funds
A mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both.
They allow people with small amounts of money to easily diversify.

Financial Intermediaries
Other Financial Institutions
Credit unions
Pension funds
Insurance companies
Loan sharks

Some Important Identities
Recall that GDP is both total income in an economy and total expenditure on the economy’s output of goods and services:
Y = C + I + G + NX
Assume a closed economy – one that does not engage in international trade:
Y = C + I + G

Some Important Identities
Now, subtract C and G from both sides of the equation:
Y – C – G =I
The left side of the equation is the total income in the economy after paying for consumption and government purchases and is called national saving, or just saving (S).
Substituting S for Y - C - G, the equation can be written as:
S = I

The Meaning of Saving and Investment
National Saving
National saving is the total income in the economy that remains after paying for consumption and government purchases.
Private Saving
Private saving is the amount of income that households have left after paying their taxes and paying for their consumption.
Private saving = (Y – T – C)
Public Saving
Public saving is the amount of tax revenue that the government has left after paying for its spending.
Public saving = (T – G)

The Meaning of Saving and Investment
Surplus and Deficit
If T > G, the government runs a budget surplus because it receives more money than it spends.
The surplus of T - G represents public saving.
If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue.

The Meaning of Saving and Investment
For the economy as a whole, saving must be equal to investment.
S = I

THE MARKET FOR LOANABLE FUNDS
Financial markets coordinate the economy’s saving and investment in the market for loanable funds.

THE MARKET FOR LOANABLE FUNDS
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds.
Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.

Supply and Demand for Loanable Funds
The supply of loanable funds comes from people who have extra income they want to save and lend out.
The demand for loanable funds comes from households and firms that wish to borrow to make investments.

Supply and Demand for Loanable Funds
The interest rate is the price of the loan.
It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving.
The interest rate in the market for loanable funds is the real interest rate.
Financial markets work much like other markets in the economy.
The equilibrium of the supply and demand for loanable funds determines the real interest rate.

Summary
National income accounting identities reveal some important relationships among macroeconomic variables.
In particular, in a closed economy, national saving must equal investment.
Financial institutions attempt to match one person’s saving with another person’s investment.