Macro Tut 4 - Saving, Investment and the Financial System

Multiple Choice: Identify the choice that best completes the statement or answers the question.

1. At the broadest level, the financial system moves the economy’s scarce resources from
a. the rich to the poor.
b. financial institutions to business firms and government.
c. households to financial institutions.
d. savers to borrowers.

2. A perpetuity is distinguished from other bonds in that it

a. pays continuously compounded interest.
b. pays interest only when it matures.
c. never matures.
d. will be used to purchase another bond when it matures unless the owner specifies otherwise.

3. The prices of stock traded on exchanges are determined by

a. the Corporate Stock Administration.
b. the administrators of NASDAQ.
c. the supply of, and demand for, the stock.
d. All of the above are correct.

4. A high demand for a company’s stock is an indication that

a. the company is in need of funds.
b. the company has recently sold a large quantity of bonds.
c. people are optimistic about the company’s future.
d. people are pessimistic about the company’s future.

5. Which of the following statements is correct?

a. Stocks, bonds, and deposits are all similar in that each provides a common medium of exchange.
b. Most buyers of stocks and bonds prefer those issued by large and familiar companies.
c. Banks charge borrowers a slightly lower interest rate than they pay to depositors.
d. None of the above is correct.

6. Which of the following are financial intermediaries?

a. both banks and mutual funds
b. banks but not mutual funds
c. mutual funds but not banks
d. neither banks or mutual funds

7. Which of the following equations will always represent GDP in an open economy?
a. S = I - G
b. I = Y - C + G
c. Y = C + I + G
d. Y = C + I + G + NX

8. In a closed economy, national saving is

a. usually greater than investment.
b. equal to investment.
c. usually less than investment because of the leakage of taxes.
d. always less than investment.

9. The country of Hykenia does not trade with any other country. Its GDP is $20 billion. Its government
collects $4 billion in taxes and pays out $3 billion to households in the form of transfer payments.
Consumption equals $15 billion and investment equals $2 billion. What is public saving in Hykenia, and
what is the value of the goods and services purchased by the government of Hykenia?
a. -$2 billion and $3 billion
b. $1 billion and $3 billion
c. -$1 billion and $4 billion
d. There is not enough information to answer the question.

10. In a closed economy, public saving is the

a. amount of income that households have left after paying for taxes and consumption.
b. amount of income that businesses have left after paying for the factors of production.
c. amount of tax revenue that the government has left after paying for its spending.
d. sum of A, B, and C.

11. A budget surplus is created if

a. the government sells more bonds than it buys back.
b. the government spends more than it receives in tax revenue.
c. private saving is greater than zero.
d. None of the above is correct.

12. The slope of the demand for loanable funds curve represents the
a. positive relation between the real interest rate and investment.
b. negative relation between the real interest rate and investment.
c. positive relation between the real interest rate and saving.
d. negative relation between the real interest rate and saving.

13. In the loanable funds model, an increase in an investment tax credit would create a
a. shortage at the former equilibrium interest rate. This shortage would lead to a rise in the interest
rate.
b. shortage at the former equilibrium interest rate. This shortage would lead to a fall in the interest
rate.
c. surplus at the former equilibrium interest rate. This surplus would lead to a rise in the interest
rate.
d. surplus at the former equilibrium interest rate. This surplus would lead to a fall in the interest
rate.

14. An increase in the budget deficit

a. makes investment spending fall.
b. makes investment spending rise.
c. does not affect investment spending.
d. may increase, decrease, or not affect investment spending.

15. Bolivia had a smaller budget deficit in 2003 than in 2002. Other things the same, we would expect this
reduction in the budget deficit to have
a. increased both interest rates and investment.
b. increased interest rates and decreased investment.
c. decreased interest rates and increased investment.
d. decreased both interest rates and investment.

16. If the government instituted an investment tax credit, then which of the following would be higher in
equilibrium?
a. saving and the interest rate
b. saving but not the interest rate
c. the interest rate but not saving
d. neither saving nor the interest rate

Figure 26-1. The figure depicts a demand-for-loanable-funds curve and two supply-of-loanable-funds
curves.
 S1 S2

Demand

17. Refer to Figure 26-1. Which of the following events would shift the supply curve from S1 to S2?
a. In response to tax reform, firms are encouraged to invest more than they previously invested.
b. In response to tax reform, households are encouraged to save more than they previously saved.
c. Government goes from running a balanced budget to running a budget deficit.
d. Any of the above events would shift the supply curve from S1 to S2.

EXERCISES AND PROBLEMS

Exercise 1: Fill the blank with NO MORE THAN 4 WORDS:

1. The budget balance is the difference between …tax revenue………….. and government spending.
2. ……National Saving……………………, the sum of private savings and the budget balance, is the
total amount of savings generated within the economy.
3. The loanable funds market is a hypothetical market that examines the ……market
outcome……………… of the demand for funds generated by borrowers and the supply of funds
provided by lenders.
4. …Interest rate…………………. is the price, calculated as a percentage of the amount borrowed,
charged by the lender to a borrower for the use of their savings for one year.
5. Crowding out is the …negative………… effect of budget deficits on private investment.
6. A household’s wealth is the value of its…accumulated saving……………………...
7. Bond purchasers can acquire information …free of charge……… on the quality of the bond issuer,
rather than having to incur the expense of investigating it themselves.
8. The …loanable fund market……………………….. shows how loans from savers are allocated
among borrowers with investment spending projects.
9. According to the savings–investment spending identity, savings and investment spending are always
…equal………. for the economy as a whole.
10. …A bank………. is a financial intermediary that provides liquid assets in the form of bank deposits
to lenders and uses those funds to finance the illiquid investments or investment spending needs of
borrowers.
 Exercise 2: Find the underlined parts that are incorrect in these statements and correct them:

11. Investors typically wish to reduce their risk by engaging in diversification, owning a narrow (wide)
A B C

range of assets whose returns are based on unrelated, or independent, events.

D
12. The budget deficit is the difference between tax revenue and government spending when

A B C
tax revenue exceeds (less than) government spending.
D
13. A liability is an option(requirement) to pay income in the future.
A B C D
14. A loan is a lending agreement between government (particular lender) and a particular borrower.
A B C D
15. Shareowners are able to enjoy the lower (higher) returns over time that stocks generally offer in

A B C
comparison to bonds.
D

Problem 1:
Identify each of the following acts as representing either saving or investment.
a. Lan uses some of his income to buy government bonds.  Saving
b. Minh takes some of his income and buys mutual funds.  Investment
c. Linh purchases a new truck for his delivery business using borrowed funds.  Investment
d. Peter uses some of his income to buy stock in a major corporation.  Saving
e. Dave hires a builder to construct a new home using borrowed funds.  Investment

Problem 2:
Suppose GDP equals $10 trillion, consumption equals $6.5 trillion, the government spends $2 trillion and has a budget
deficit of $300 billion.
a. Find public saving, taxes, private saving, national saving, and investment.
b. Suppose now that the government cuts taxes by $200 billion. In each of the following two scenarios, determine what
happens to public saving, private saving, national saving, and investment.
1. Consumers save the full proceeds of the tax cut.
2. Consumers save 1/4 of the tax cut and spend the other 3/4

Problem 3:
Graphically show the impact on the loanable fund in each of the following scenario
a. The economy is in a recession and buinesses begin to expect it will continue indefinitely.
b. Technological advancements increase productivity for firms who make new investements.
c. The Government increases taxes by $100 million and decreases spending by $100 million
d. Hyper inflation increase the incentive for consumers to spend
e. There is a significant increase in business confidence
f. The government increases spending by $1 trillion to fund infrastructure projects like roads, bridges and upgrades to
the electrical grid.