Section 5 Lecture December 2016 Mr. Gammie AP Macroeconomics Section 5 Lecture December 2016 Mr. Gammie

MONEY

Module 22: Saving, Investment, and the Financial System

When a firm invests money in machinery, equipment, factories, they usually do so by borrowing money. Where does that money come from?

Simple Economy No gov’t No trade --- all money spent by consumers and firms ends up in another persons pocket as profit

Total Income = Total Spending Total Spending = GDP = C+I+G+Xn

You have $500 of disposable income for the month of December You have $500 of disposable income for the month of December. What can you do with it? MPC + MPS = 1 Spend or Save

Some Math… Total Income = Total Spending Total Income = C + S Total Spending = C + I C + S = C + I Therefore….. S = I

Savings = Investment

+ Government Budget Balance = tax revenue – gov’t spending – transfer payments Budget surplus (+) Budget deficit (-) National Saving = S + BB S = I S = National Saving = Private Saving + BB Surplus – investment increases Deficit – investment decreases

+ Other Countries Capital Inflow = the total inflow of foreign funds minus the total outflow of domestic funds to other countries I = S S = National Saving + Capital Inflow Capital inflow = investment increases Capital outflow = investment decreases

Financial market – where households invest their current savings, accumulated savings, wealth

Three Tasks of a Financial System Reduce Transaction Costs vs. Pork, apples, and bread Supermarket = bank

Three Tasks of a Financial System Reducing Risk Owners can spread risk by selling shares in their company.

Diversification: investing in several assets with unrelated, or independent risks. It allows a business owner to lower his/her total risk of loss. Key Takeaway: The desire of individuals to reduce their total risk by engaging in diversification is why we have stocks and the stock market.

Three Tasks of a Financial System Providing Liquidity

Financial Assets Financial Asset: A paper claim that entitles the buyer to future income from the seller. Four Types: Loans Bonds Loan Backed Securities Stocks

Financial Intermediaries Financial Intermediary: an institution that transforms funds gathered from many individuals in financial assets. Three Key Types: Mutual Funds Pension Funds and Life Insurance Companies Banks

Review Question Economists view investment spending as which of the following: Stocks Bonds Spending on physical capital Mutual investment spending Spending on human capital c

Review Question Given: Closed Economy S=I In a closed economy suppose that GDP is $12 trillion. Consumption is $8 trillion, government spending is $2 trillion, and taxes are $0.5 billion. How much is national saving? $2 trillion $3 trillion $3.5 trillion $4 trillion None of the above a

Review Questions Financial markets: Increase transaction costs Reduce diversification Provide liquidity Determine tax rates Are the same as resource markets c

Module 22 Summary The saving investment identity tells us that, in a simple economy without gov’t or foreign trade, that private dollars saved must equal private dollars invested. When the gov’t is included we discover that they can also contribute to the national savings if there is a budget surplus, and can detract from national savings if there is a budget deficit. Money can also flow into Canada from foreign citizens and money can flow out of Canada into foreign economies. This inflow or outflow affects domestic saving and investment. If more money flows in to Canada than leaves Canada to other nations, there is a capital inflow. This increases domestic investment. (Vice versa applies). The financial system facilitates transactions between savers and investors and provides three key roles in this process: reducing transaction costs, reducing risk, and increasing liquidity.

Module 23: The Definition and Measurement of Money

Define: money

Average price of a home?

How much is this car?

Money and wealth are often confused, we need to separate money from assets that have value What makes this $20 different from you’re your laptop, cell phone, car, or even tooth brush for that matter? Which one could you bring to the subway across the street to exchange for a sub? --- only the $20 --- that is the key difference.

Defined: money is any asset that can easily be used to purchase goods and services. Of course you could take your laptop, or cell phone and sell it for money then bring that money to subway. Or you could give your cell phone to subway in exchange for a sub. But how many subs will you get? This is barter. Barter is one of the things money reduces the need for.

Roles of Money Medium of Exchange Imagine you have just worked al week in your summer job. Your employer has decided to pay you in apples. They give you 1 bushel of apples, obviously more than you can eat on your own. What would you do with those apples? You could try to sell them, or bring them to another place and try to trade them.

Roles of Money Store of Value As long as there is not rapid inflation, money is a good way to store value. You can put money in your bank account and it will still be useful – essentially be of the same value- -- a week or month later. Cheese maker, store all your value in cheese, cheese will go bad

Roles of Money Unit of Account How much is this house, car, toothbrush? in money? In terms of the other … Value is measured on a consistent scale.

Types of Money Commodity Money ex. Commodity-backed Money ex. Fiat Money ex. https://www.youtube.com/watch?v=ADaY6THQp3Y

Measuring the Money Supply M1: currency and coin in circulation + checking deposits + travelers checks M2: M1 + savings accounts + short term CDs + money market accounts *Review this section in your textbook. CD = certificate of deposit

Review Question Suppose you transfer $500 from your checking account to your savings account. With this transaction M1 _____ and M2 _____. Increased; stayed the same Stayed the same; increased Decreased; stayed the same Decreased; increased Increased; decreased c

Review Question The narrowest definition of money excludes: Savings accounts Traveler’s checks Currency in circulation Checkable bank deposits Coins in circulation a

Review Question The medium of exchange function means that money is used: As the common denominator of prices As the common denominator of future payments. To save and earn interest income. To accumulate purchasing power. To pay for goods and services. e

Module 23 Summary Money is not the same as wealth. Money is essentially anything that is easily exchangeable for goods and services. Many things have been used as money by different human civilizations. All successful forms of money must serve as a medium of exchange, a store of value, and unit of account. Two aggregate measures of the money supply are M1 and M2. M1 is the narrowest definition. You will most often work with this definition. M2 adds several other assets, known as near-moneys, that can easily be converted into cash. HW: M22 CYU 1, 2 MC 1-5, FR 2 HW: M23 CYU 1, 3 MC 1-5, FR 2