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Financial Institutions
in the U.S. Economy
The financial system is made up of
financial institutions that coordinate the
actions of savers and borrowers.
Financial institutions can be grouped
into two different categories: financial
markets and financial intermediaries.
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Financial Institutions
in the U.S. Economy
Financial Markets
Stock Market
Bond Market
Financial Intermediaries
Banks
Mutual Funds
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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.
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Characteristics of a Bond
Term: The length of time until the bond
matures.
Credit Risk: The probability that the
borrower will fail to pay some of the
interest or principal.
Tax Treatment: The way in which the tax
laws treat the interest on the bond.
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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.
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Banks
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.
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Financial Intermediaries:
Mutual Funds
A mutual
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unions
Pension funds
Insurance companies
Loan sharks
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Y = C + I + G + NX
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Y=C+I+G
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Y C G =I
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S=I
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S=I
S=YCG
S = (Y T C) + (T G)
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Private Saving
Private saving = (Y T
C)
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Public Saving
Public saving = (T G)
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S=I
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Supply
5%
Demand
$1,200
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Loanable Funds
(in billions of
and saving
Taxes and investment
Government budget deficits
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Supply, S1
1. Tax incentives
for saving
increase the
supply of loanable
funds...
Demand
5%
4%
2. ...which
reduces the
equilibrium
interest
rate...
S2
$1,20
0
$1,60
0
Loanable Funds
(in billions of
dollars)
3. ...and raises the equilibrium quantity of loanable
funds.
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Supply
1. An investment
tax credit
increases the
demand for
loanable funds...
6%
5%
2. ...which
raises the
equilibrium
interest
rate...
D2
Demand, D1
$1,400
$1,20
0
3. ...and raises
the
equilibrium quantity of
Loanable Funds
(in billions of
dollars)
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S2
Supply, S1
1. A budget
deficit decreases
the supply of
loanable funds...
Demand
$800
$1,200
0
Loanable Funds
(in billions of dollars)
3. ...and reduces the
equilibrium quantity of
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U.S. government
debt
4
0
2
0
0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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Summary
The U.S. financial system is made up of
financial institutions such as the bond
market, the stock market, banks, and
mutual funds.
All these institutions act to direct the
resources of households who want to save
some of their income into the hands of
households and firms who want to borrow.
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Summary
National income accounting identities
reveal some important relationships
among macroeconomic variables.
In particular, in a closed economy,
national saving must equal investment.
Financial institutions attempt to match
one persons saving with another
persons investment.
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Summary
The interest rate is determined by the
supply and demand for loanable funds.
The supply of loanable funds comes from
households who want to save some of
their income.
The demand for loanable funds comes
from households and firms who want to
borrow for investment.
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Summary
National saving equals private saving plus
public saving.
A government budget deficit represents
negative public saving and, therefore,
reduces national saving and the supply of
loanable funds.
When a government budget deficit
crowds out investment, it reduces the
growth of productivity and GDP.
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Graphical
Review
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Supply
5%
Demand
$1,200
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Loanable Funds
(in billions of
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Supply, S1
1. Tax incentives
for saving
increase the
supply of loanable
funds...
Demand
5%
4%
2. ...which
reduces the
equilibrium
interest
rate...
S2
$1,20
0
$1,60
0
Loanable Funds
(in billions of
dollars)
3. ...and raises the equilibrium quantity of loanable
funds.
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Supply
1. An investment
tax credit
increases the
demand for
loanable funds...
6%
5%
2. ...which
raises the
equilibrium
interest
rate...
D2
Demand, D1
$1,400
$1,20
0
3. ...and raises
the
equilibrium quantity of
Loanable Funds
(in billions of
dollars)
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S2
Supply, S1
1. A budget
deficit decreases
the supply of
loanable funds...
Demand
$800
$1,200
0
Loanable Funds
(in billions of dollars)
3. ...and reduces the
equilibrium quantity of
U.S. government
debt
4
0
2
0
0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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