1. AP Economics Mr. Bernstein Module 22: Saving, Investment and the Financial System February 25, 2015

2. AP Economics Mr. Bernstein Saving, Investment and the Financial System Objectives - Understand each of the following: The relationship between savings and investment spending The purpose of the four principal types of financial assets: stocks, bonds, loans and bank deposits How financial intermediaries help investors achieve diversification and help firms source funding of physical capital 2

3. AP Economics Mr. Bernstein The Savings-Investment Spending Identity Assume a simple economy – no G, no X n Total Income = Total Spending All money spent winds up in another’s pocket as income Total Income = Consumption + Savings Total Spending = Consumption + Investment So C + S = C + I…and S = I 3

4. AP Economics Mr. Bernstein The Savings-Investment Spending Identity, cont. Adding in Government Budget Balance (BB) = Tax revenue – G – Transfers BB > 0 is a surplus, BB < 0 is a deficit Now we have S + BB = I Notice is BB is a deficit, I must decrease 4

5. AP Economics Mr. Bernstein The Savings-Investment Spending Identity, cont. Adding in Capital Inflows/Outflows Investors can save in home country or overseas Capital Inflow (CI) is foreign savings coming into the USA minus US savings flowing out Now we have S + BB + CI = I Notice when CI > 0, I must increase 5

6. AP Economics Mr. Bernstein Three Tasks of a Financial System Reducing Transactions Costs Making it easier and less costly to engage in borrowing or other financial transactions Reducing Risk Reducing Financial Risk – ie sharing ownership Diversification – investing in assets with unrelated risks Providing Liquidity Ease of turning asset into cash Done via loans, stocks, bonds 6

7. AP Economics Mr. Bernstein Key Financial System Terms Wealth = accumulated savings Financial Asset = Paper Claim to future income Loans: Lending agreement between borrower and lender Bonds: Promise by seller to pay fixed amount of payments plus all principal on maturity date Loan-Backed Securities: Pool of loans “securitized” Stocks: Slices or “shares” of ownership Physical Assets Liabilities 7