ECODEV
Banks
Saving, Investment, and the
Financial System
 The financial system consists of the group
of institutions in the economy that help to
match one person's saving with another
person's investment.
 It moves the economy's scarce resources
from savers to borrowers.
FINANCIAL INSTITUTIONS IN THE
U.S. ECONOMY
 Financial markets are the institutions
through which savers can directly provide
funds to borrowers.
 Financial intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers.
Financial Intermediaries: Banks
 Banks take deposits from people who want
to save and use the deposits to make loans to
people who want to borrow.
 Banks pay depositors interest on their
deposits and charge borrowers slightly
higher interest on their loans.
Financial Markets
 The Stock Market
o Stock represents a claim to partial
ownership in a firm and is therefore,
a claim to the profits that the firm
makes.
o The sale of stock to raise money is
called equity financing.
 Compared to bonds, stocks
offer both higher risk and
potentially higher returns.
o The most important stock exchanges
in the United States are the New
York Stock Exchange, the American
Stock Exchange, and NASDAQ.
o Bond Prices react to interest rates.
o If a bond is paying 10% and interest
rates go to 5% is the bonds price
going to go up or down?
o What if interest rates go to 15% what
is that bond going to be worth?
o See 2010 Question 2 AP Test.
o So if interest rates go up bond prices
go down and vice versa.
 Banks help create a medium of exchange by
allowing people to write checks against their
deposits.
 A medium of exchanges is an item that
people can easily use to engage in
transactions.
 This facilitates the purchases of goods and
services
National Income Accounts
 National saving-the total income in the
economy that remains after paying for the
consumption and government purchases.
Y = C+ I + G + NX
Remember that GDP can be divided up into four
components: consumption, investment, government
purchases, and net exports.
National Savings
 So Y=C+0+1
 To isolate investment, we can subtract C and
O from both sides:
 Y-C-G=l
 Or GDP- Consumption-Govemment
Purchases = Investment
 What is left is called national savings.
 Savings=Y-C-G=1
 Savings =Investing
*Savings are not the same as Investing
You will have to keep reminding students what the
term "investment' means to macroeconomists.
Outside of the economics profession, most people
use the terms "saving" and "investing"
interchangeably.
In macroeconomics, investment refers to the
purchase of new capital, such as equipment or
buildings. (factories)
If an individual spends less than he earns and uses
the rest to buy stocks or mutual funds, economists
call this saving.
Definition of National Saving (Saving): the total
income in the economy that remains after paying for
consumption and government purchases
Saving Continued
 Savings=GDP-Consumption-Govt Spending
 If T= Taxes and Transfer payments back to
SS and Welfare It car be broken down also
like this S=(Y-T-C) + (T-G)
  This breaks down into private savings and
public savings
 Private Saving: the income that households
have left after paying for taxes and
consumption.
 Public Saving: the tax revenue that the
government has left after paying for its
spending.
 Budget Surplus: an excess of tax revenue
over government spending.
 Budget Deficit: a shortfall of tax revenue
from government spending.
Breaking down National Income
 NS=(Y-T-C) + (T - G)
 NS=(Y-T-C) = Private Savings
 (T - G) = Public Savings
 Private Savings - The amount of income
that households have left after paying their
taxes and paying for their consumption
 Public Savings - The amount of tax revenue
that the government has left after paying for
it spending
Types Of Savings
 Budget Surplus – if government receives
more than they pay out. T-G is positive
 Budget Deficit – T-G is negative
The important point to make here is that with a
government budget deficit, public saving is negative
and the public sector is thus "dissaving." To make
up for this shortfall, it must go to the loanable funds
market and borrow the money. This will reduce the
supply of loanable funds available for investment.
Is there a Social Cost to extended
Unemployment?
At first the job seeker optimistically looks for his
next job.
Then after many rejections, he becomes a
reluctant discourage worker
With pressure from bill collectors (and his wife),
he holds up an ATM called Kenny and shoots it.
Eventually he is caught and incarcerated.
And his kids will cry because they can no loner
go to college.
And the Taxes Justice System will tell him to
“Take That”
Social Cost of Unemployment
Social Cost of unemployment
 Crime rates move with the business
cycle...rising during periods of high
unemployment and falling during periods of
low unemployment. The crime statistics
released in the fall of 1997 bear this out.
With unemployment at a 25-year low at
4.9% the rate of violent crime was down for
a fifth consecutive year, and the murder rate
fell to its lowest level since 1969. FBI crime
statistics show that both property crime and
violent crime Increased sharply between
1985 and 1991 and fell dramatically from
1991 to 1997 in step with unemployment
How Is Unemployment Measured?
 The labor force participation rate is the
percentage of the adult population that is in
the labor force.
 Labor force participation rate
o (Labor force / Adult population) x
100
Types of Unemployment
 Frictional Unemployment: unemployment
due to the natural "frictions of the economy,
which is caused by changing market
conditions and is represented by "qualified
individuals" with "transferable skills" who
change jobs.
 Structural Unemployment: unemployment
due to structural changes in the economy
that eliminate some jobs and create others
for which the unemployed are "not
qualified" So they have "nontransferable
skills
 Natural Unemployment Rate: The sum of
the Frictional Unemployment Rate and the
Structural Unemployment Rate.
 Full Employment: when the unemployment
rate is equal to the natural unemployment
rate.
 Cyclical Unemployment Rate: the
difference between the unemployment rate
and the natural unemployment rate. This is
due to deficient demand & implies a
"recession"
Frictional unemployment
 refers to the unemployment that results from
the time that it takes to match workers with
jobs.
o In other words, it takes time for
workers to search for the jobs that
are best suit their tastes and skills.
Structural unemployment
  is the unemployment that results because the ensuring that all workers would be fully
number of jobs available in some labor employed.
markets is insufficient to provide a job for
everyone who wants one.

Cyclical Unemployment
 Cyclical unemployment refers to the year-
to-year fluctuations in unemployment
around its natural rate.
 It is associated with short-term ups and
downs of the business cycle.

Full Employment Public Policy and Job Search •

 Because Frictional and Structural
unemployment are unavoidable does not
count against unemployment.
 Cyclical unemployment does.
 Thus 100 percent employment is not truly
100 percent.
 If there were no cyclical unemployed in the
economy we would have 100 percent
employed.
 Unemployment insurance
o increases the amount of search
unemployment
o reduces the search efforts of the
unemployed.
o may improve the chances of workers
being matched with the right jobs

Natural Rate of Unemployment

 The natural rate of unemployment is
unemployment that does not go away on its
own even in the long run.
 It is the amount of unemployment that the
economy normally experiences.

Definition of "Full Employment"

1. Full employment does not mean zero
unemployment
2. The full-employment unemployment rate is
equal to the total frictional and structural
unemployment
3. The full-employ rate of unemployment is
also referred to as the natural rate of
unemployment
4. 4 The natural rate is achieved when labor
markets are in balance; the number of job
seekers equals the number of job vacancies
At this point the economy's potential output
is being achieved. The natural rate of
unemployment is not fixed, but depends on
the demographic makeup of the labor force
and the laws and customs of the nations. The
recent drop in the natural rate from 6 to
5.5% has occurred mainly because of the
aging of the work force and increased
competition in product and labor markets

Why Are There Always Some People

Unemployed?
 In an ideal labor market, wages would adjust
to balance the supply and demand for labor.