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AP Economics

This module explores the fundamental relationship between saving and investment, key financial assets (stocks, bonds, loans, and bank deposits), and the role of financial intermediaries in enhancing diversification and funding for firms. We delve into the Savings-Investment Identity in a simple economy, examine the impact of government budget balances, and analyze capital flows. The module concludes with an overview of the critical functions of a financial system, including reducing transaction costs, managing financial risk through diversification, and providing liquidity to facilitate financial transactions.

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AP Economics

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  1. AP Economics Mr. Bernstein Module 22: Saving, Investment and the Financial System March 6, 2014

  2. AP EconomicsMr. Bernstein Saving, Investment and the Financial System • Objectives - Understand each of the following: • The relationship between savings and investment spending • The purpose of the four principal types of financial assets: stocks, bonds, loans and bank deposits • How financial intermediaries help investors achieve diversification and help firms source funding of physical capital

  3. AP EconomicsMr. Bernstein The Savings-Investment Spending Identity • Assume a simple economy – no G, no Xn • Total Income = Total Spending • All money spent winds up in another’s pocket as income • Total Income = Consumption + Savings • Total Spending = Consumption + Investment • So C + S = C + I…and S = I

  4. AP EconomicsMr. Bernstein The Savings-Investment Spending Identity, cont. • Adding in Government • Budget Balance (BB) = Tax revenue – G – Transfers • BB > 0 is a surplus, BB < 0 is a deficit • Now we have S + BB = I • Notice is BB is a deficit, I must decrease

  5. AP EconomicsMr. Bernstein The Savings-Investment Spending Identity, cont. • Adding in Capital Inflows/Outflows • Investors can save in home country or overseas • Capital Inflow (CI) is foreign savings coming into the USA minus US savings flowing out • Now we have S + BB + CI = I • Notice when CI > 0, I must increase

  6. AP EconomicsMr. Bernstein Three Tasks of a Financial System • Reducing Transactions Costs • Making it easier and less costly to engage in borrowing or other financial transactions • Reducing Risk • Reducing Financial Risk – ie sharing ownership • Diversification – investing in assets with unrelated risks • Providing Liquidity • Ease of turning asset into cash • Done via loans, stocks, bonds

  7. AP EconomicsMr. Bernstein Key Financial System Terms • Wealth = accumulated savings • Financial Asset = Paper Claim to future income • Loans: Lending agreement between borrower and lender • Bonds: Promise by seller to pay fixed amount of payments plus all principal on maturity date • Loan-Backed Securities: Pool of loans “securitized” • Stocks: Slices or “shares” of ownership • Physical Assets • Liabilities

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