Savings and Investment Flashcards
(89 cards)
1
Q
What is a cartesian plane used for
A
- To show consumption today and tomorrow
- Each point shows an inter-temporal consumption profile
2
Q
What are the 4 basic inter-temporal decisions an individual can make
A
- Borrowing
-Lending - Investing
- Storing
3
Q
What does borrowing do
A
Bring consumption forward in time
4
Q
What is the opporunity cost of borrowing
A
Lower consumption in the future
5
Q
What is the repayment equation
A
Repayment = principal + interest
6
Q
What is the interest rate
A
The price of bringing buyer power forward in time
7
Q
What is the feasible set
A
Inter-temporal consumption combinations available at current interest rates
8
Q
What is the feasible frontier
A
inter-temporal consumption combinations that exhaust total consumption
9
Q
What can you do if you’re not at the frontier
A
You can increase consumption today and/or tomorrow
10
Q
If someone has say $100 in the future, how can consumption be brought to the present
A
Under an interest rate, eg under 10% $91 can be brought to the present
11
Q
What is the slope of the feasible frontier
A
Marginal Rate of Transformation (MRT)
12
Q
What happens to the feasible set when the interest rate increases
A
It shrinks
13
Q
What is the diminishing marginal returns to consumption
A
The value of an additional unit of consumption in a given period declines the more it is consumed
14
Q
What does smoothing consumption over time mean, what does the graph show
A
- If all Julia’s income is in the future, she could smooth her consumption by bringing some future income to the present
- Thus she can reach a higher IC with higher utility
15
Q
What is the slope of the indifference curve
A
The marginal rate of substitution
16
Q
What does a steeper MRS mean
A
The more future consumption someone is willing to substitute for a unit of present consumption
17
Q
What does a reservation indifference curve show
A
The level of utility someone can reach without borrowing
18
Q
How can an individual smooth their consumption if they have all their consumption in the future
A
Borrow
19
Q
Explain how can someone smooth consumption by borrowing
A
- An individual borrows at current interest rates and thus can reach a higher IC with higher utility
20
Q
What is the optimal borrowing point to reach the highest IC
A
when MRS=MRT
21
Q
What does a higher interest rate imply about consumption and ICs
A
- Higher price of consumption today
- Lower IC, lower utility
22
Q
What does lending mean
A
Moving consumption to the future
23
Q
What is the opportunity cost of lending
A
Lower consumption today
24
Q
In what way does lending help smooth consumption
A
From present to future
25
Explain pure impatience
- Preferring to consumer more today instead of perfectly smoothing consumption
- Pure impatience means higher reservation IC than someone who chooses to consumer later
26
Explain how someone can smooth consumption by lending
- Individual lends and thus consumes less now and more later
- This allows them to reach a higher indifference curve with higher utility
27
What is the optimal lending point
MRS=-MRT
28
Other than lending, how can someone move consumption to the future
Investing
29
What is the benefit of having income today
You have more choices, you can store, lend or invest
30
How could an individual smooth consumption by investing
- They choose to invest and eg if return was 50% they would reach a higher IC than if they lended
31
What is present value
The amount of money today that would need to be invested using prevailing interest rates to produce a given future amount of money
32
What is future value
An amount of money in the future that an amount of money invested today would yield given prevailing interest rates
33
Where do students have most of their income
In the future
34
Where do retirees have most of their income
In the past
35
What does risk averse mean
Disliking uncertainty
36
What implies risk aversion and is show on the graph
Diminishing marginal utility (of wealth)
37
What are the two types of risk
- Idiosyncratic risk- affects a single economic actor
- Aggregate risk- affects all actors at once
38
What is diversification
Reducing risk by replacing a single risk with a large number of smaller unrelated risks
39
What does the graph show about diversification
As the no. of stocks in a portfolio increase, the risk of the portfolio decreases
40
What type of stocks have a higher return and standard deviation
Risky Stocks
41
What is the trade off between risk and return
-High risk, high return
- Positive relationship
42
What are financial institutions
Groups of institutions in the economy that help match one person's saving with another person's investment
43
What are financial markets
Financial institutions through which savers can directly provide funds to borrowers
44
What are the two main financial markets
- Bond market
- Stock market
45
How can a company borrow to finance a project from the public
Buy issuing a bond
46
What is a bond
A certificate of indebtedness
47
What type of finance is a bond
debt finance
48
What does a bond identify
- Date of maturity
- Rate of interest paid
49
What are the two main characteristics of bonds to consider
- Term: the length of maturity until the bond matures
- Credit risk: probability of default
50
What is sovereign debt
When the government also issues bonds
51
What is the bond yield equation
yield = coupon/price x 100
52
What government bonds are considered risk free
US treasury bills (T bills)
53
Other than bonds, how else can funds be raised for a project
selling stocks
54
What is a stock
A claim to partial ownership and future profits in a firm
55
What way is raising money through stocks and shares called
Equity finance
56
What are primary markets
Stock exchanges where corporations can issue stock by selling shares
57
What are secondary markets
Markets where stockholders can trade shares
58
What determines the price of stocks
Supply and demand on stock exchanges
59
What does the price of a stock reflect
Peoples' perception of the firms future profitability
60
What are financial intermediaries
Institutions which savers can provide funds to borrowers
61
What are the two main types of financial intermediaries
- Banks
- Investment funds
62
What is the main function of a bank
To take in deposits and use them to make loans
63
How do banks cover costs and return profits
By paying depositors lower interest rates than they charge for loaners
64
What are investment funds
Institutions that sell to the public and use the proceeds to buy a portfolio of stocks and bonds
65
What do investment funds allows people with small amounts of money to do
Diversify and thus have lower risk
66
What is GDP
Both total income and expenditure on the economy's output of goods and services
67
What are the 4 components of expenditure that GDP can be divided into
- Consumption
- Investment
- Government purchases
- Net exports
68
What is the national saving equation
GDP - consumption - government spending
69
What is national saving equal to
Investment
70
What does saving reappear as in the economt through financial institutions
Investment
71
What is national saving broken down to
- Private saving (GDP-consumption-investment)
- Public saving ( Tax rev- gov spending)
72
What is a budget surplus
When gov tax revenue is greater than spending
73
What is a budget deficit
When government tax revenue is less than spending and the government has to finance spending
74
What does investment refer to for macroeconomists
The purchase of new capital, equipment or buildings
75
What is the difference between government debt and deficit
- Government debt t is a stock and refers to the accumulation of debt owed by the government at a given time
- Whereas deficit is a stock and refers to a budget deficit over a given period
76
What is the market for loanable funds
Market in which those who wants to save supply funds, and those who want to borrow to invest demand funds
77
What is the supply for loanable funds
People who have extra income they want to save and lend out (either directly like bonds or through banks)
78
What is demand for loanable funds
Firms or households who wish to borrow to make investments
79
What is the price of loanable funds
The real interest rate
80
what explains why demand for loanable funds is downward sloping
An increase in interest rates makes lending and thus saving more attractive
81
Why is supply of loanable funds upward sloping
An increase in the interest rate makes lending and thus saving more attractive
82
What causes changes in the interest rate
Shifts in the S/D of/for loanable funds
83
How could incentives for savings be provided
By changing the income tax to a consumption tax eg special savings accounts to shelter income from taxes
84
How does interest elasticity of demand effect the impact of policies on national savings
- The higher the interest elasticity of demand, the higher the impact on national savings
85
How does can tax incentives for savings increase the quantity for loanable funds
- Tax incentives for savings increase supply of loanable funds
- Loanable funds supply shifts out lowering IRs
- This also raises equilibrium quantity of loanable funds
86
How can the government incentivise investment
By introducing investment tax credits whereby they gain tax advantages for investing
87
How would investment incentives raise the equilibrium quantity of loanable funds
- Investment tax credit policy increases demand for loanable funds so shifts our
- This increase equilibrium interest rate and quantity of loanable funds
88
How does a government deficit decrease the supply of loanable funds
Deficit means a decrease in public savings and thus national savings
89
Explain using graph how a budget deficit causes a decrease in loanable funds/ investment (CROWDING OUT)
- Budget deficit means decrease in national savings via less public savings, this shifts supply of loanable funds inwards
- Inward shift cause increase in interest rates deterring investment as well as a decrease in loanable funds
