Module Saving, Investment, and the Financial System KRUGMAN'S MACROECONOMICS for AP* 22 Margaret Ray and David Anderson

What you will learn in this Module : 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

Physical Capital (factories, shopping malls, machinery, etc. – usually paid through borrowing.)Physical Capital (factories, shopping malls, machinery, etc. – usually paid through borrowing.) The Source of Physical Capital (must come from somewhere – what happens when this “dries up”?)The Source of Physical Capital (must come from somewhere – what happens when this “dries up”?) Matching up Savings and Investment Spending

The Savings-Investment Spending Identity Assume a simple economy Total Income = Total Spending Total Income = Consumption + Savings Total Spending = Consumption+ Investment Consumption + Savings = Consumption + Investment.: Savings = Investment

The Savings-Investment Spending Identity Now, more complexity Budget Surplus Budget Deficit Budget Balance National Savings v. Private Savings Capital inflow

Wealth Financial Asset Physical Asset Liability The Financial System

Three Tasks of a Financial System Reducing Transaction Costs Reducing Risk Financial Risk Diversification Providing Liquidity Liquid Illiquid

Types of Financial Assets Loans Bonds Default Loan-backed Securities (Collateralized Debt Obligation - CDO) Stocks

Types of Financial Assets Loans 1.Loans A loan is a lending agreement between an individual lender and an individual borrower. Bonds 2. Bonds The seller of a bond promises to pay a fixed sum of interest each year and to repay the principal—the value stated on the face of the bond—to the owner of the bond on a particular date. Loan-backed Securities 3. Loan-backed Securities (Key to 2008 Financial Collapse) Loan-backed securities are assets created by pooling individual loans and selling shares in that pool (a process called securitization). (Key to 2008 Financial Collapse) 4.Stocks A stock is a share in the ownership of a company.

Financial Intermediaries Mutual Funds Pension Funds Life Insurance Companies Banks Bank deposit Fractional reserve banking