Chapter 9-1
Financial institutions build a bridge between savers and borrowers.
If people have saved enough for their retirement, they can have a smooth consumption path over their lives. If greater life expectancy means that not enough has been saved for retirement, then consumption during the retirement years will have to be lower than currently planned. Thus, the consumption path throughout their lifetimes will not be smooth.
Other than retirement, numerous potential things can generate a demand to save because these things can cause income to be volatile: loss of a job, chronic illness, or accidents that cause some bodily harm. One saves for a rainy day.
Chapter 9-2
Under the lifecycle theory, individual savings are likely to be at their peak during an individual’s prime earning years.
If interest rates fall from 7% to 5%, all else being equal, this is a fall in the price of borrowed funds. This fall in price will encourage more people to buy homes (they now may be able to afford something they could not afford before) or start businesses.
Chapter 9-3
Greater patience will shift the supply of savings curve to the right, leading to an increase in the quantity of savings and a decrease in the equilibrium interest rate.
B-8
An increase in investment demand shifts the demand curve to the right, leading to an increase in the equilibrium interest rate and an increase in the quantity of funds demanded and supplied.
Chapter 9-4
The primary role of financial intermediaries is to reduce the costs of moving savings from savers to borrowers and investors.
Interest rates and bond prices move in opposite directions. If you own a bond paying 6% in interest and the interest rate falls to 4%, the price of the bond must go up. If interest rates rise to 8%, the price of the 6% bond must fall.
An IPO is a first-time sale of a firm’s stock to the market, and so usually increases net investment: The firm can take this new capital and use it to expand the business. Buying shares of stock from someone else, in contrast, is buying shares already issued and represents a transfer of ownership, not a net increase to investment: The firm does not get the purchase price of the stock.
Chapter 9-5
Usury laws are price ceilings. Remember from Chapter 5 that price ceilings cause shortages. If savers can get only the ceiling rate rather than the market rate for their savings, they will save less.
Bank failures can hinder financial intermediation in a variety of ways. If savers become reluctant to put their money in banks, for example, the supply of credit will decline and the cost of borrowing will rise. This can lead to a credit crisis as credit dries up.
Lending money to political cronies, or pals, lowers the efficiency of the economy because loans do not go to their highest-valued uses.
Chapter 10-1
According to the efficient markets hypothesis, one cannot consistently beat the market. Therefore, past performance is not a good guide to future success. On average, mutual funds that have performed well in the past are no more likely to perform well in the future than mutual funds that performed poorly in the past.
Chapter 10-2
Investing in the stocks of other countries helps to diversify your investments because the economies of other countries do not always rise and fall at the same time as the U.S. economy. If all economies tended to rise and fall together, there would not be any large benefits in diversifying across countries.
If many people dream of owning a football or baseball team, it is likely that the rewards to owning one go beyond monetary rewards. Thus, the monetary return on these assets is likely to be relatively low.
B-9
Chapter 10-3
This question is being hotly debated by many economists. It can be said that identifying and bursting bubbles is more difficult than it looks. How does the Federal Reserve know when there is a bubble? Increases in prices do not necessarily signify a bubble. Even if it can be said to be fairly certain that a bubble is present, how does the Federal Reserve burst the bubble while avoiding widespread collateral damage?
Chapter 11-1
Frictional unemployment is caused by the ordinary difficulties of matching employee to employer. A reason for the difficulty of matching employer to employee is scarcity of information.
Some frictional unemployment is not bad if it means that prospective employers and prospective employees take the time to determine whether they are a good fit. Being forced to take the first job offered is not a good way to establish a good fit.
Chapter 11-2
Structural unemployment is persistent, long-term unemployment caused by long-lasting shocks or permanent features of an economy that make it more difficult for some workers to find jobs.
In the United States, “employment at-will” fairly accurately describes the employment situation: Employees may quit at any time and employers may fire an employee at any time and for any reason. In contrast, laws in Western European countries hinder the ability of employers to act at will. For example, in Portugal any business must get the government’s permission to lay off workers, and even then the business must follow guidelines as to who can be laid off first.
Chapter 11-2
Cyclical unemployment is determined by the business cycle. It increases during a recession and decreases during a boom.
Lower growth is correlated with increasing unemployment; higher growth is correlated with decreasing unemployment.
Chapter 11-3
Lowering the marginal tax rate for married couples provided an incentive for more women to enter the labor force because they could now keep more of their pay rather than have it taxed away.
Raising the age that one can obtain Social Security benefits increases the incentive to stay in the labor force longer, thus increasing the labor force participation rate.
B-10
Chapter 12-1
Using the formula in section “Defining and Measuring Inflation,” (125 − 120) ÷ 120 = 4.16%.
If the inflation rate goes from 1% to 4% to 7% over a period of two years, the prices of a great majority of goods are likely to go up.
Use real prices rather than nominal prices to compare the price of goods over time. Real prices subtract out the effect of inflation and thus give a better measure of whether a particular good is becoming more or less expensive over time compared to most other goods and services.
Chapter 12-2
In the long run, inflation is always and everywhere a monetary phenomenon: Growth in the money supply causes inflation.
The quantity theory of money is Mv = PY.
Chapter 12-3
Under unexpected inflation, wealth is redistributed from lenders to borrowers. Under unexpected disinflation, wealth is redistributed from borrowers to lenders.
When the expected inflation rate increases, nominal interest rates rise to compensate. We call this the Fisher effect.
Unexpected inflation distorts price signals. They become more difficult to interpret. This leads to waste.