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Private saving
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is equal to what households retain of their income after purchasing goods and services (C) and paying taxes (T).
SPrivate = Y+TR−C−T.
Y = GDP
C = consumption
SPrivate = Y+TR−C−T.
Y = GDP
C = consumption
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transfer payments (TR)
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Households also receive income from government in the form of TR, which include Social Security payments and unemployment insurance payments.
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Public saving (SPublic)
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equals the amount of tax revenue the government retains after paying for government purchases and making transfer payments to households
SPublic = T−G−TR.
SPublic = T−G−TR.
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total saving in the economy (S) is equal to ...
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the sum of private saving and public saving:
S=SPrivate+SPublic,
S=Y−C−G.
S=SPrivate+SPublic,
S=Y−C−G.
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S=I
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We can conclude that total saving must equal total investment:
S=I.
S=I.
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balanced budget.
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When the government spends the same amount that it collects in taxes
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budget deficit.
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When the government spends more than it collects in taxes
We can conclude that, holding constant all other factors, there is a lower level of investment spending in the economy when there is a budget deficit than when there is a balanced budget.
We can conclude that, holding constant all other factors, there is a lower level of investment spending in the economy when there is a budget deficit than when there is a balanced budget.
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budget surplus
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When the government spends less than it collects in taxes
A higher level of saving results in a higher level of investment spending. Therefore, holding constant all other factors, there is a higher level of investment spending in the economy when there is a budget surplus than when there is a balanced budget.
A higher level of saving results in a higher level of investment spending. Therefore, holding constant all other factors, there is a higher level of investment spending in the economy when there is a budget surplus than when there is a balanced budget.
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market for loanable funds
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We can think of the financial system as being composed of many markets through which funds flow from lenders to borrowers: the market for certificates of deposit at banks, the market for stocks, the market for bonds, the market for mutual fund shares, and so on.
In the loanable funds model, the interaction of borrowers and lenders determines the market interest rate and the quantity of loanable funds exchanged.
In the loanable funds model, the interaction of borrowers and lenders determines the market interest rate and the quantity of loanable funds exchanged.
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Demand and Supply in the Loanable Funds Market
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The demand for loanable funds is determined by the willingness of firms to borrow to engage in new investment projects, such as building new factories or carrying out research and development of new products.
In determining whether to borrow, firms compare the return they expect to make on an investment with the interest rate they must pay to borrow the necessary funds.
The demand for loanable funds is downward sloping because the lower the interest rate, the more investment projects firms can profitably undertake, and the greater the quantity of loanable funds they will demand.
In determining whether to borrow, firms compare the return they expect to make on an investment with the interest rate they must pay to borrow the necessary funds.
The demand for loanable funds is downward sloping because the lower the interest rate, the more investment projects firms can profitably undertake, and the greater the quantity of loanable funds they will demand.
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Supply of loanable funds is determined by...
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The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. When households save, they reduce the amount of goods and services they can consume and enjoy today.
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The Market for Loanable Funds
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The demand for loanable funds is determined by the willingness of firms to borrow to engage in new investment projects. The lower the interest rate the better as they pay a lower interest rate for taking out a loan. The lower the interest rate, the more investment projects firms can profitably undertake, and the greater the quantity of loanable funds they will demand.
The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. The higher the interest rate the better as they get more money back from savings. The higher the interest rate, the greater the reward for saving and the larger the amount of funds households will save.
Equilibrium in the market for loanable funds determines the real interest rate and the quantity of loanable funds exchanged.
The supply of loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. The higher the interest rate the better as they get more money back from savings. The higher the interest rate, the greater the reward for saving and the larger the amount of funds households will save.
Equilibrium in the market for loanable funds determines the real interest rate and the quantity of loanable funds exchanged.
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nominal interest rate
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is the stated interest rate on a loan.
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real interest rate
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corrects the nominal interest rate for the effect of inflation and is equal to the nominal interest rate minus the inflation rate.
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What does equilibrium determine?
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Equilibrium in the market for loanable funds determines the quantity of loanable funds that will flow from lenders to borrowers each period. Equilibrium also determines the real interest rate that lenders will receive and that borrowers must pay.
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Increase the quantity of loanable funds?
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An increase in the quantity of loanable funds means that both the quantity of saving by households and the quantity of investment by firms have increased.
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When a governments run a deficit ...
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Running a deficit has reduced the level of total saving in the economy and, by increasing the interest rate, has also reduced the level of investment spending by firms.
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Crowding out
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By borrowing to finance its budget deficit, the government will have crowded out some firms that would otherwise have been able to borrow to finance investment
Refers to a decline in private expenditures (in this case, investment spending) as a result of an increase in government purchases.
Lower investment spending decreases the capital stock and the quantity of capital per hour worked.
Refers to a decline in private expenditures (in this case, investment spending) as a result of an increase in government purchases.
Lower investment spending decreases the capital stock and the quantity of capital per hour worked.
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A government budget surplus
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A budget surplus increases the total amount of saving in the economy, shifting the supply curve for loanable funds to the right. In the new equilibrium, the interest rate will be lower, and the quantity of loanable funds will be higher.
We can conclude that a budget surplus increases the level of saving and investment.
We can conclude that a budget surplus increases the level of saving and investment.
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An increase in the government's budget deficit
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- Will shift the supply of loanable funds curve to the left (decrease the supply)
- Causing the real interest rate to increase and investment to decrease
- Causing the real interest rate to increase and investment to decrease
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An increase in the desire of households to consume today
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- Will shift the supply of loanable funds curve to the left (decrease the supply)
- Causing the real interest rate to increase and investment to decrease
- Causing the real interest rate to increase and investment to decrease
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An increase in tax benefits for saving, such as 401(k) retirement accounts, which increase the incentive to save
answer
- Will shift the supply of loanable funds curve to the right (increase the supply)
-Causing the real interest rate to decrease and investment to increase
-Causing the real interest rate to decrease and investment to increase
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An increase in expected future profits
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- Will shift the demand for loanable funds curve to the right (increase the demand of firms)
-Causing the real interest rate to increase and investments to increase
-Causing the real interest rate to increase and investments to increase
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An increase in corporate taxes
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- Will shift the demand for loanable funds curve to the left (decrease the demand of firms)
- Causing the real interest rate to decrease and investments to decrease
- Causing the real interest rate to decrease and investments to decrease
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Expansion phase of business cycle
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Production, employment, and income are increasing.
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Business cycle peak.
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The period of expansion ends with a business cycle peak.
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Recession phase of business cycle
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Following the business cycle peak, production, employment, and income decline
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Business cycle trough
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The recession comes to an end with a business cycle trough, after which another period of expansion begins.
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Recession
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"A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade."
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The Business Cycle
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1. As the economy nears the end of an expansion, interest rates are usually rising, and the wages of workers are usually increasing faster than prices. As a result of rising interest rates and wages, the profits of firms will be falling. Typically, toward the end of an expansion, both households and firms will have substantially increased their debts. These debts are the result of the borrowing that firms and households undertake to help finance their spending during the expansion. Rising debts can eventually lead households and firms to reduce their spending.
2. A recession will often begin with a decline in spending by firms on capital goods, such as machinery, equipment, new factories, and new office buildings, or by households on new houses and consumer durables, such as furniture and automobiles. As spending declines, firms that build houses and firms that sell capital goods and consumer durables will find their sales declining. As sales decline, firms cut back on production and begin to lay off workers. Rising unemployment and falling profits reduce income, which leads to further declines in spending.
3. As the recession continues, economic conditions eventually begin to improve. The declines in spending finally come to an end; households and firms begin to reduce their debts, thereby increasing their ability to spend; and interest rates decline, making it more likely that households and firms will borrow to finance new spending. Firms begin to increase their spending on capital goods as they anticipate the need for additional production during the next expansion. Increased spending by households on new houses and consumer durables and by businesses on capital goods will finally bring the recession to an end and begin the next expansion.
2. A recession will often begin with a decline in spending by firms on capital goods, such as machinery, equipment, new factories, and new office buildings, or by households on new houses and consumer durables, such as furniture and automobiles. As spending declines, firms that build houses and firms that sell capital goods and consumer durables will find their sales declining. As sales decline, firms cut back on production and begin to lay off workers. Rising unemployment and falling profits reduce income, which leads to further declines in spending.
3. As the recession continues, economic conditions eventually begin to improve. The declines in spending finally come to an end; households and firms begin to reduce their debts, thereby increasing their ability to spend; and interest rates decline, making it more likely that households and firms will borrow to finance new spending. Firms begin to increase their spending on capital goods as they anticipate the need for additional production during the next expansion. Increased spending by households on new houses and consumer durables and by businesses on capital goods will finally bring the recession to an end and begin the next expansion.
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Are durable or nondurable goods more affected by the business cycle?
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Durable goods
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Price level
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Measures the average prices of goods and services in the economy
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Inflation rate
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Is the percentage increase in the price level from one year to the next
We can measure the inflation rate as the percentage change in the CPI from one year to the next.
We can measure the inflation rate as the percentage change in the CPI from one year to the next.
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Does the inflation rate rise or fall during a recession?
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The inflation rate falls
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Does the inflation rate rise or fall during a expansion?
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The inflation rate rises, especially at the end of an expansion
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Does real GDP measure economic growth?
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No, real GDP does not, the percentage change in real GDP does measure the economic growth.
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Expansions and Recessions length since 1950s
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Expansions have increased and recessions have decreased (except in the Great Recession)
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Why is the U.S. economy relatively stable?
answer
Shorter recessions, longer expansions, and less severe fluctuations in real GDP have resulted in a significant improvement in the economic well-being of Americans.
1. The increasing importance of services and the declining importance of goods.
2. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed.
3. Active federal government policies to stabilize the economy. In the years since World War II, the federal government has actively used macroeconomic policy measures to try to end recessions and prolong expansions. Many economists believe that these government policies have played a key role in stabilizing the economy.
4. The increased stability of the financial system. Great Depression and Recession had severe instability within the banks, failing banks, and decrease in stock prices making it difficult for firms to sell stocks
1. The increasing importance of services and the declining importance of goods.
2. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed.
3. Active federal government policies to stabilize the economy. In the years since World War II, the federal government has actively used macroeconomic policy measures to try to end recessions and prolong expansions. Many economists believe that these government policies have played a key role in stabilizing the economy.
4. The increased stability of the financial system. Great Depression and Recession had severe instability within the banks, failing banks, and decrease in stock prices making it difficult for firms to sell stocks
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Why do service goods stabilize the economy?
answer
Manufacturing production, particularly of durable goods such as automobiles, fluctuates more than the production of services because during a recession, households will cut back more on purchases of durables than they will on purchases of services. So, the increase in services as a percentage of GDP may have helped to stabilize the economy.
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Rule of 70
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Number of years to double= 70/Growth rate.
For example:
If real GDP per capita is growing at a rate of 5 percent per year, it will double in 70/5=14 years.
If real GDP per capita is growing at a rate of 2 percent per year, it will double in 70/2=35 years.
For example:
If real GDP per capita is growing at a rate of 5 percent per year, it will double in 70/5=14 years.
If real GDP per capita is growing at a rate of 2 percent per year, it will double in 70/2=35 years.
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The importance of small differences in growth rates
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Small differences in growth rates can have large effects on how rapidly the standard of living in a country increases.
Even small differences can accumulate to huge increase
Even small differences can accumulate to huge increase
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Capital per hour worked:
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Capital per hour worked: Refers to the manufactured goods that are used to produce other goods and services, such as computers, factory buildings, machine tools, and warehouses.
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GDP GROWTH RATE
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The growth rate of real GDP per capita for a particular year equals its percentage change from the previous year. The average annual growth rate provides the growth rate for longer periods of time.
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How to find growth rate and number of years doubled
answer
To find growth rate use percentage change meaning
Year 2-Year 1 / Year 1 x 100 = growth rate
To find Number of years to double
Rule of 70:
70/growth rate (percent NOT number)
Year 2-Year 1 / Year 1 x 100 = growth rate
To find Number of years to double
Rule of 70:
70/growth rate (percent NOT number)
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Financial System
answer
Financial system The system of financial markets and financial intermediaries through which firms acquire funds from households.
The system shares the risk of lending, provides liquidity to savers, and collects and communicates information about borrowers.
The system shares the risk of lending, provides liquidity to savers, and collects and communicates information about borrowers.
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Financial markets
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Markets where financial securities, such as stocks and bonds, are sold.
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Private savings is equal to:
answer
S= Y + TR - C - T
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Public Savings is equal too:
answer
S= T-G-TR
G= government spending
OR:
S public = I - S private
G= government spending
OR:
S public = I - S private
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Does inflation rate rise or fall during a recession?
answer
Inflation rate peaks at the end of an expansion and then drops significantly in the recession
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An increase in the real interest rate:
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will cause a movement along the demand curve for loanable funds
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Lower interest rate better or worse for firms?
answer
Better because lower interest rates will make more investment options viable for the firm. The expected return on the investment can be lower and the project may still be viable if the firm can borrow at even lower interest rate.
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