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Principles of Economics

Chapter26Saving,Investment,and the Financial System

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What we learned from previous chapter

•  Chapter23 :Components of GDP

•  Chapter24 :Inflation rate CPI

•  Chapter25 :A country's standard living depends on its ability to produce goods and service and

and productivity depends on

–  physical capital

–  human capital

–  natural resources

–  technological knowledge

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How do we match one person's saving

with another person's investment?

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Chapter26 Index

1. Financial Institution

2. Saving and Investment in the National Income Accounts

3. The Market for loanable funds

(building a model of financial markets)

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Ten Principles of Economics

Ⅰ.How People Make Decisions. 1:People Face Trade-offs.

2:The Cost of Something Is What You Give Up to Get It.

3:Rational People Think at the Margin.

4:People Respond to Incentives.

Ⅱ.How People Interact. 5:Trade Can Make Everyone Better Off.

6:Markets Are Usually a Goodway to Organize Economic Activity.

7:Governments Can Sometimes Improve Market Outcomes.

Ⅲ.How the Economy as a Whole Works 8:A Country's Standard of Living Depends on its Ability to Produce Goods and Services.

9:Prices Rise When the Government Prints Too Much Money.

10:Society Faces a Short-Run Trade-off between Inflation and Umemployment.

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Financial System

Financial Systems

one person's Saving

Another person's Investment

the financial system moves the economy's scarce resources from savers to borrowers

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Financial Markets and Financial Intermediaries

Financial Markets

Financial Intermediaries

The Bond Markets (Debt finance)

The Stock Markets (Equity finance)

Banks

Mutual Funds

Bond maturity

Credit Risk

Tax treatment

Owner ship

Stock exchange

Stock Index

Deposit

Loan

Medium of exchange

Access skills of professional money manager

diverse portfolio stocks and bonds

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Direcrt Finance and Indirect Finance

　　　Corporations (Borrower)

Bank (Indirect finance)

house holds Investors 　(Savers)

Deposit Loan

Market (Direct finance)

Investment

Stocks,Bonds

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Chapter26 Index

1. Financial Institution

2. Saving and Investment in the National Income Accounts

3. The Market for loanable funds

(building a model of financial markets)

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National Saving

Y= C + I + G + NX we assume a closed economy,so NX=0

Y =C + I + G ⇔ Y - C - G = I　⇔　S = I

S = Y - C - G

S = ( Y - T - C ) + ( T - G )　　　　　　　　　　　　　　

National Savings

National Savings Private Savings Government Savings

Y:GDP C:Consumption I:Investment G:Government purchases NX:Net Exports

S:National Savings

Financial Markets

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National Saving asssuming open economy

Y=C+I+G+NX(EX-IM) expenditure aspect・・・①

Y=C+S+T allocation aspect・・・②

Substitute① for ②

C + I + G + EX - IM = C + S + T

S - I 　　　　＝ 　　　G - T + 　EX - IM

(S + T) - ( I + G)　＝　EX - IM

Private Savings budget deficit

National savings Trade surplus

Trade surplus

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Japan exports and Imports

(単位：億円)

Trade Balance Exports Imports

1996 88,140 435,088 (346,948)

1997 120,928 494,847 (373,919)

1998 158,258 488,854 (330,596)

1999 137,618 457,759 (320,141)

2000 123,759 494,912 (371,153)

2001 84,544 465,944 (381,400)

2002 115,443 494,442 (378,999)

2003 119,600 519,015 (399,415)

2004 139,112 582,459 (443,347)

2005 102,944 625,177 (522,233)

2006 94,048 715,502 (621,454)

2007 123,484 797,383 (673,899)

2008 41,383 774,329 (732,946)

2009 40,240 508,001 (467,761)

2010 79,354 638,838 (559,484)

2011 (13,674) 575,086 (588,760)

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Japan exports and Imports

(Unit:億円)

excluding data of Dec 2011

http://www.mof.go.jp/international_policy/reference/balance_of_payments/bpnet.htm

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(単位：億円)

Current Account Goods &Services Income Current Transfers

1996 71,035 22,940 58,031 (9,937)

1997 117,106 57,626 70,103 (10,619)

1998 155,521 96,220 70,711 (11,410)

1999 131,508 78,314 65,538 (12,342)

2000 129,483 74,572 65,458 (10,548)

2001 106,539 32,762 83,596 (9,818)

2002 140,324 64,727 82,477 (6,876)

2003 157,545 83,311 83,166 (8,932)

2004 186,479 102,046 93,068 (8,630)

2005 184,153 76,381 115,736 (7,966)

2006 199,124 72,555 138,921 (12,351)

2007 247,395 98,443 162,571 (13,616)

2008 165,352 20,034 158,895 (13,574)

2009 133,149 21,208 123,336 (11,395)

2010 171,603 65,136 117,706 (11,240)

2011 88,651 (28,759) 128,937 (11,527)

Japan Current account

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Japan Current account

excluding data of Dec 2011

http://www.mof.go.jp/international_policy/reference/balance_of_payments/bpnet.htm

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国際収支発展段階説

内閣府ホームページ http://www5.cao.go.jp/keizai3/shihyo/2005/1205/681.html

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The meaning of saving and investment

In a language of macroeconomics,

q  Investment:

the purchase of new capital,such as equipment or building.

q Buying stocks or bonds:

savings rather than investment.

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Chapter26 Index

1. Financial Institution

2. Saving and Investment in the National Income Accounts

3. The Market for loanable funds

(building a model of financial markets)

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Supply and Demand for Loanable Funds

5%

1,200

Interest rate

Loanable Funds

Supply

demand

q The supply of loanbel funds: coming from national savings,including both private savings and public savings

q The demand of loanbel funds: coming from household and firms who wish to borrow to make investment

Figure1 P565

q Interest rate: the price of loan and adjusting to balance the supply and demand for loanables funds

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Three steps to analyzing changes in equilibrimu from Chapter4

1. Decide wether the event shifts the supply or demand curve(or perhaps both)

2. Decide in which direction the curve shifts

3. Use the supply-and-supply diagram to see how the shifts changes the equilibrium price and quantity.

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Policy1:Saving Incentives

5%

1,200

Interest rate

Loanable Funds

Supply1

demand

q 1st Step: A change in the tax law to encourage people to save more wolud shift the supply.

q 2nd Step: The supply would increase,and the supply curve would shift to the right.

Figure2 P567

q 3rd Step: The increases supply reduces the interest rate from 5% to 4%.

4%

Supply2

1,500

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Policy2:Investment incentives

6%

1,200

Interest rate

Loanable Funds

Supply

Demand1

q 1st Step: The passage of investment tax credit to encourage firms to invest more would shift the demand.

q 2nd Step: The demand would increase,and the demand curve would shift to the right.

Figure3 P568

q 3rd Step: The quantity of loanable funds demanded raise the interest rate from 5% to 6%.

5%

1,400

Demand2

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Policy3:Government budget deficits and surplus

6%

1,200

Interest rate

Loanable Funds

Supply1

demand

q 1st Step: A change in the government budget balance represents a change in public saving,and in the supply of lonable funds.

q 2nd Step: A budget deficit the supply curve for loanable funds to the left.

Figure4 P569

q 3rd Step: The budget deficit reduces the supply of lonable funds,the interest rate rises from 5%to 6%.

5%

Supply2

1,500

Crowding Out!!

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The history of JPN Government debt

http://www.mof.go.jp/gallery/20110308.htm

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The debt of the JPN GDP as a percentage of GDP

http://www.mof.go.jp/gallery/20110309.htm

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Conclusion

•  Financial markets serve the important role of linking the present and the future

•  Those who supply loanable funds do so because they want to convert some of their current income into future purchasing power.

•  Well-functioning financial markets are important not only for current generations but also for future generations.