290 section 5 The Financial Sector
1.Given the following information about the closed economy of
Brittania, what is the level of investment spending and private
savings, and what is the budget balance? What is the relation-
ship among investment spending, private savings, and the
budget balance? Is national savings equal to investment spend-
ing? There are no government transfers.
GDP=$1,000 million T=$50 million
C=$850 million G=$100 million
2.Which of the following are examples of investment spending,
investing in financial assets, or investing in physical assets?
a.Rupert Moneybucks buys 100 shares of existing Coca -Cola
stock.
b.Rhonda Moviestar spends $10 million to buy a mansion
built in the 1970s.
c.Ronald Basketballstar spends $10 million to build a new
mansion with a view of the Pacific Ocean.
d.Rawlings builds a new plant to make catcher’s mitts.
e.Russia buys $100 million in U.S. government bonds.
3.Explain how a well-functioning financial system increases sav-
ings and investment spending, holding the budget balance and
any capital flows fixed.4.What are the important types of financial intermediaries in
the U.S. economy? What are the primary assets of these inter-
mediaries, and how do they facilitate investment spending
and saving?
5.For each of the following transactions, what is the initial effect
(increase or decrease) on M1? or M2?
a.You sell a few shares of stock and put the proceeds into
your savings account.
b.You sell a few shares of stock and put the proceeds into
your checking account.
c.You transfer money from your savings account to your
checking account.
d.You discover $0.25 under the floor mat in your car and de-
posit it in your checking account.
e.You discover $0.25 under the floor mat in your car and de-
posit it in your savings account.
6.There are three types of money: commodity money, commodity -
backed money, and fiat money. Which type of money is used in
each of the following situations?
a.Bottles of rum were used to pay for goods in colonial
Australia.Problems
Interest rate, p. 222
Savings–investment spending identity, p. 222
Budget surplus, p. 223
Budget deficit, p. 223
Budget balance, p. 223
National savings, p. 223
Capital inflow, p. 223
Wealth, p. 224
Financial asset, p. 224
Physical asset, p. 224
Liability, p. 224
Transaction costs, p. 225
Financial risk, p. 225
Diversification, p. 225
Liquid, p. 226
Illiquid, p. 226
Loan, p. 226
Default, p. 226
Loan-backed securities, p. 227
Financial intermediary, p. 227
Mutual fund, p. 228
Pension fund, p. 228
Life insurance company, p. 228
Bank deposit, p. 229
Bank, p. 229
Money, p. 231
Currency in circulation, p. 231
Checkable bank deposits, p. 231
Money supply, p. 231
Medium of exchange, p. 232
Store of value, p. 232
Unit of account, p. 233
Commodity money, p. 233
Commodity -backed money, p. 234
Fiat money, p. 234
Monetary aggregate, p. 234
Near -moneys, p. 235
Present value, p. 239
Net present value, p. 240
Bank reserves, p. 243
T-account, p. 243
Reserve ratio, p. 244
Required reserve ratio, p. 244
Bank run, p. 246
Deposit insurance, p. 246
Reserve requirements, p. 246
Discount window, p. 246
Excess reserves, p. 249
Monetary base, p. 249
Money multiplier, p. 250
Central bank, p. 253
Commercial bank, p. 257Investment bank, p. 257
Savings and loan (thrift), p. 257
Leverage, p. 258
Balance sheet effect, p. 258
Vicious cycle of deleveraging, p. 258
Subprime lending, p. 259
Securitization, p. 259
Federal funds market, p. 263
Federal funds rate, p. 263
Discount rate, p. 263
Open -market operation, p. 264
Short-term interest rates, p. 269
Long-term interest rates, p. 270
Money demand curve, p. 270
Liquidity preference model of the interest
rate, p. 273
Money supply curve, p. 273
Loanable funds market, p. 277
Rate of return, p. 278
Crowding out, p. 281
Fisher effect, p. 283Key Terms