Lecture 11 Flashcards
(12 cards)
Bond Spread
Corporate Bond Yield- Treasury Yield of the Same Maturity
Why would investors demand fewer corporate bonds?
There is a higher likelihood of bankruptcy; They switch to demanding safer assets like treasury bonds
Demand of loanable funds
Investment (business borrowing to build factories must be satisfied by supply of loanable funds)
Supply of Loanable Funds
Household Savings, Government Savings, Foreign Savings
Why is Saving Supply curve mostly upward sloping?
As S.E. > I.E., then when rate increase, household saving increase
Why is investment demand curve downward sloping?
Firms maximize its profit by choosing capital level where r=MPK (diminishing marginal product of capital)
When interest rate increases…
Future consumption is higher (each dollar saved earns more); When interest rate rises, the budget line rotates to represent more returns on saving (so you can consume more tomorrow) and higher cost to borrow (so you can borrow less)
Interest Rate Rises-Substitution Effect is Greater Than Income Effect
The person with yellow indifference curve chooses to consume less today and save more today for tomorrow; Opportunity cost to consume now increase
Interest Rate Rises- Income Effect Is Greater than Substitution Effect
Chooses to consume more today; Each dollar saved has more compounding rate, each dollar saved gets you more future consumption; Marginal utility of income decrease-> less willingness to save.
Should you pay taxes now or pay later?
Better to not have a refund since you could have used that overpaid money to invest or purchase consumption that you would have to pay higher interest on credit cards
Ricardian Equivalence
Tax cut today, coupled with budget deficit means tax increase in the future
Modigliani-Miller Theorem
It does not matter if you finance your company with debt or equity, you achieve the same profitability
