Financial Macroeconomics By: Carley Dubinski ECO 106- Prof. Sebastien Mary

Stock, Bond, or Mutual Fund? This is like an, “IOU”. A company, municipal, or government may issue this, with the promise of being paid back in full, with interest. This has a specified term and risk.

Stock, Bond, or Mutual Fund? This is a portfolio of various types of financial assets, that one can purchase a share of. It allows for greater diversification, and can even be owned by people who are only willing to invest a small amount of money.

Stock, Bond, or Mutual Fund? This is a claim to a share of the company, and therefore possibly its profits. It comes with high risk and potentially high returns, however.

Saving Assume we are in a closed economy, what is the formula for the GDP? Y= C + I +G

Saving Now, keep in mind, in a closed economy, you have two options of what you can do with your income. You can save it, or spend it (consume). And what money you do save, is being invested - in a savings account for example. How can you rearrange this equation so it reads savings is equal to investment. Y - C - G = I S N = I

Saving So we now understand that S=I. But we must remember that national savings is broken up into private and government savings. We must add taxes to our equations. So we know the government saves what they do not spend, just like we do as consumers. And we know consumers save, and therefore invest, what they do not spend or pay in taxes.

Saving So, S G = T - G S P = Y - T - C Therefore: S N = S P + S G S N = (Y - T - C) + (T - G)

Market For Loanable Funds Who are the suppliers and who are the demanders in the market for loanable funds? Draw and correctly label the graph for the market for loanable funds.

Figure 1 The Market for Loanable Funds Loanable Funds (in billions of dollars) 0 Interest Rate Supply Demand 5% $1,200 Copyright©2004 South-Western

Scenarios 1.Taxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save. 2.A tax decrease increases the incentive for households to save at any given interest rate. 3.If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment. 4.An investment tax credit increases the incentive to borrow. 5.If a change in tax laws encourages greater investment, the result will be higher interest rates and greater saving. 6.When government reduces national saving by running a deficit, the interest rate rises and investment falls. (Crowding out). 7.When government increases national saving by running surplus, the interest rate decreases and investment increases.

Scenarios Taxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save. -Decreases the supply of loanable fund.

Scenarios A tax decrease increases the incentive for households to save at any given interest rate. The supply of loanable funds curve shifts to the right. The equilibrium interest rate decreases. The quantity demanded for loanable funds increases.

Figure 2 An Increase in the Supply of Loanable Funds Loanable Funds (in billions of dollars) 0 Interest Rate Supply,S1S1 S2S which reduces the equilibrium interest rate and raises the equilibrium quantity of loanable funds. Demand 1. Tax incentives for saving increase the supply of loanable funds... 5% $1,200 4% $1,600 Copyright©2004 South-Western

Scenarios If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment. Increase in the supply of loanable funds

Scenarios An investment tax credit increases the incentive to borrow. Increases the demand for loanable funds. Shifts the demand curve to the right. Results in a higher interest rate and a greater quantity saved.

Scenarios If a change in tax laws encourages greater investment, the result will be higher interest rates and greater saving. Increase in the demand for loanable funds

Figure 3 An Increase in the Demand for Loanable Funds Loanable Funds (in billions of dollars) 0 Interest Rate 1. An investment tax credit increases the demand for loanable funds which raises the equilibrium interest rate and raises the equilibrium quantity of loanable funds. Supply Demand,D1D1 D2D2 5% $1,200 6% $1,400 Copyright©2004 South-Western

Scenarios When government reduces national saving by running a deficit, the interest rate rises and investment falls. (Crowding out). Decrease in the supply of loanable funds.

Scenarios When government increases national saving by running surplus, the interest rate decreases and investment increases. Increase in the supply of loanable funds.