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Chapters 26 & 27

Chapters 26 & 27. Twofer Day!!!. Dark side video. Overview. Discussion of saving & investing Why is it so important Where does it come from How much does it cost LOANABLE FUNDS market graph CROWDING OUT 27 SLIDES. Why does it all matter?. Last chapter focused on growth

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Chapters 26 & 27

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  1. Chapters 26 & 27 Twofer Day!!!

  2. Dark side video

  3. Overview • Discussion of saving & investing • Why is it so important • Where does it come from • How much does it cost • LOANABLE FUNDS market graph • CROWDING OUT • 27 SLIDES

  4. Why does it all matter? • Last chapter focused on growth • How is that concept connected here? • Why is saving & investing critical?

  5. BUY CAPITAL, BUY CAPITAL • More capital = higher productivity • Higher productivity = higher output • Higher output = more stuff • NOT SPENDING ALL YOUR MONEY IS CRITICAL • FORGOING PRESENT CONSUMPTION ALLOWS US TO INCREASE POTENITAL OUTPUT FOR THE FUTURE • LOOK AT THE GRAPH

  6. Need to not spend…it all • Is GDP hurt? • GDP = C + I + G + X • When we don’t spend, we save • What happens to the leftover money? • Banks loan it to other people who want to borrow

  7. Financial Intermediaries • Think about it as a picture • FINANCIAL SYSTEM allows borrowers to connect w/ those w/ money to lend • FINANCIAL MARKETS involves these transactions • 2 most common: Bond & Stock Markets

  8. They’re both MARKETS • Governed by individual incentive & supply/demand • Bond Market: essentially a loan to person looking to borrow • Stock Market: part ownership in the endeavor itself • All about capital (money) going back & forth

  9. Reminder • Money & currency are different…how? • MONEY is anything that: • Medium of Exchange: buy & sell stuff • Unit of Account: comparing values • Store of Value: save for later • Financial intermediaries include banks, credit unions, savings & loan institutions, & MUTUAL FUNDS (DIVERSIFICATION)

  10. Breather

  11. Following Saving • Keeping track of money is important • Accountants do that for a living • NATIONAL INCOME ACCOUNTING involves doing it on a national level • Most common thing to follow is GDP

  12. CIGX • GDP (or Y) = CIGX • For now we assume a CLOSED ECONOMY • No foreign component (compared to OPEN) • Manipulating yields GDP-C-G=I • Since any money not spent (by us or gov’t) is saved it becomes • S = I

  13. Saving = Investing • Doesn’t matter who • PRIVATE SAVING by us • PUBLIC SAVING by gov’t • Results w/ BUDGET SURPLUS as compared to BUDGET DEFICIT • Saving occurs when you don’t spend • Investing occurs when buy capital • NOT THE SAME THING…but are equal to each other • Why?

  14. Creates a New Market • Saving supplies money to be loaned (supply curve) • Investing creates demand to have money (demand curve) • Combine to form the LOANABLE FUNDS MARKET

  15. Picture it • What happens when supply or demand changes?

  16. S&I are key to future • Absolutely must do it • What helped cause the recession? • DISSAVING rate for years • Gov’t trying to correct that

  17. “Make” us do it • 1. Saving Incentives • Current plan by Obama to match personal saving • 2. Investment Incentives • Currently count half of investment as tax credit • 3. Gov’t Budget Surplus/Deficit • Uhhh ohhh

  18. What’s their impact on LF? • 1. Increases supply • Lowers IR; more attractive to borrow • 2. Increases demand • Raises IR; less attractive to borrow • 3. Greatly Increases demand • Raises IR; less attractive to borrow

  19. Enter the Federal Reserve • Now saving 5% as country • Seems huge, but still low • Balanced by companies not investing • Gov’t borrowing huge amounts • IR should go up • Held down by FED…discount rate at .25%

  20. What happens w/o FED? • Gov’t borrowing increases demand • Increases IR • Makes us less likely to borrow/spend • Goal of their spending to increase GDP but doesn’t work • CROWDING OUT

  21. In theory it balances • Chart on page 578 • Debt to GDP ratio predicted to drop to 15% by 2012 • Where are we now???

  22. Breather

  23. What is all of that stuff? • No idea what Chapter 27 actually saying • We are going to focus on the RISK

  24. Risk is the perpetual bad guy • It does nothing positive • Reduces spending, makes us uncomfortable, eliminates wealth • Nobody wants to lose money • RISK AVERSE

  25. Understanding risk • Just like playing the lottery • Risk spreading is very desirable • Add DIVERSIFICATION

  26. Case in point • Think about insurance • Why buy insurance (any type)? • Essentially betting that something bad will happen • If you win (& it does) they pay • If you lose, they keep your money

  27. 2 problems can arise • 1. Adverse Selection • Those most likely to “win” also most likely to buy insurance • 2. Moral Hazard • Having insurance makes you more likely to use it • Act less safe b/c have insurance

  28. RECAP • Answer the following: • 1. Why is saving/investing critical? • 2. What is the purpose of financial markets? • 3. Draw the loanable funds graph • 4. Define crowding out

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