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The role of the financial system in the US economy

What is the role of the financial system? Name and describe two markets that are part of the financial system in the U.S. economy. Name and describe two financial intermediaries.

The role of the financial systems is to help match one person’s savings with another’s investment in the economy.

The bond market is one of the most important financial markets in our economy. The bond is a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond. The bond is like a contract on a paper, with the maturity date and the rate in which it will be paid back to the buyers. The money that they get from the bonds can be used for something that the company needs to further the business and of course in the end should make the business more profitable and in return when the bond matures will be paid back to the purchaser with interest or either the buyer can sell at any time.

The second one is the stock market. The sale of stock is called equity finance. After the stocks are issued, by selling the shares to the public, they trade with stockholders in stock exchanges. Stocks are more of a risk than bonds but are potentially higher returns also. The price is determined by the supply and demand for the stock, or company. When there are negative things in the news about a particular company , it does change the price that people are willing to pay for a certain stock.

There are two financial intermediaries which are banks and mutual funds. An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds are called a mutual fund. The shareholder accepts all the risk.

As where banks are concerned, they pay interest on their deposits and charge the borrowers higher interest on their loans. One other difference is a bank you can write checks on a transaction.

What is the government budget deficit? How does it affect interest rates, investment, and economic growth?

The U.S. budget deficit is now smaller than it was in the same month last year at $165 Billion. For the fiscal year it comes to $1.5 Trillion. The government budget deficit is financed by borrowing in the bond market and the accumulation of past government borrowing. When there is more spent than it receives it lowers the national saving, the supply of funds that are able to be loaned decrease and the equilibrium interest rate rises. It is basically the dollar amount that is spent over income in a given period.

What benefit do people get from the market for insurance? What two problems impede the insurance market from working perfectly?

Whereas banks are concerned the FDIC will make good on deposits. As for bonds you are guaranteed your money after a certain time, so you have to pick your investments wisely. For stocks you have to watch the market if it goes too far down you will have to sell in order to get anything out of your stocks unless they rise again.

Describe the efficient markets hypothesis and give a piece of evidence consistent with this hypothesis. What does this say about using past price histories to predict future prices?

Basically stating that all market participants need to act and receive all the information as soon as it becomes available. It does not mean that the market price will be equal to a true value all the time. It could be defined more as landing on heads or tails. It is impossible to beat the market because the stock market reflects all the pertinent information to everyone. Looking at this using past price histories could land you depending on how the stock is going at the time and what the company is going thru a very sweet return. But then again it is a chance that you take because something could happen the next second to change the price and pull your stock in a less return fashion. It all depends on a company and what is happening and of course the economy.

What are the three categories into which the Bureau of Labor Statistics divides everyone? How does the BLS compute the labor force, the unemployment rate, and the labor force participation rate?

The three categories are the employed, unemployed and not in the labor force. The labor force participation rate is a measure of the percentage of the toal adult population of the us that is in that labor force.

Labor force participation rate=labor force x 100

Adult population

The unemployment rate is the percentage of labor force that is not working.

Unemployment rate = number of unemployed x 100

Labor force

The labor force is how many individuals are actually working and not working.

Labor force = number employed + number of unemployed.

Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?

Because people will always be graduating from school, or getting laid off. For any reason they may be moving and be looking for a job and will eventually find one but it may take time before they are actually back in the job market again. This could be reduced by providing public information about jobs so that they can be found more quickly to the workers that are most suitable for them.

What claims to advocates of unions make to argue that unions are good for the economy?

When unions raise the wages above the level that would prevail in competitive markets, they reduce the quantity of labor demanded, this causes some workers not to be employed and reduces the wages in the rest of the economy. But as for unions are good for the economy, they know what the company wants and what the worker wants. They come to a medium and make sure that all is happy and then everyone knows what is expected of them to keep them employed.

I know with UPS, we were approached by some leaders of the union and stated that we may be asked to join the union. The district manager got involved and stated that it is your choice, but once the laws or rules are in place, as of right now we can change them. But once the union gets involved we have to go by what was agreed upon and cannot make or break any rules until the next meeting.

What factors prevent the Fed from controlling the money supply perfectly? Explain how the Federal Reserve would set policy if it needed to contract the money supply? Be sure to include all three Fed tools in your response.

They do not have control on our individual money as consumers. The more money consumers deposit the more the reserves banks have and the more money the banking system can create, then again the less money we deposit the less money can be created.

The second problem is they do not choose the amount of money that the banks decide to lend. When there are deposits, they loan that money and creates more money for the banks. As the economy gets worse, there are fewer deposits and less lending capabilities.

The feds can raise reserve requirements or either increase the discount rate in order to contract the money supply.

The first fed tool is the open market operation which is the purchase and sale of us government bonds by the fed. This increases the money supply, the dollars the fed pays for the bonds increases the number of dollars in circulation. Each new dollar bill increases the money supply by $1.

The second tool is the reserve requirements. This is the regulations on the minimum amount of reserves that banks must hold against deposits. This influences how much money the banking system can create with each dollar in reserves.

The third is the discount rate. This is the interest rate on the loans that the fed makes to banks. They can alter the money supply by changing the discount rate. A higher rate will discourage a bank from borrowing the reserves.

Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of money?

The nominal variables are measured in monetary units, whereas the real variables are measured in physical units. An example of the nominal variable is that the gum is $4 a pack, because it is measure in monetary units. Another would be the shoes are $20 a pair, again measured in monetary units. For Real variables an example would be that a pair of shoes is five packs of gum, this we are measuring in units, not monetary value. When a pair of flip flops are $1 and a headphone set is $15 we would say that one headphone set is 15 pairs of flip flops.

Nominal variables are affected by the changes in the quantity of money according to the principle of monetary neutrality. When the dollar wage doubles this changes monetary values also.

What are the costs of inflation? Which of three costs do you think are most important for the U.S. economy?

I ran across a very neat “The inflation calculator” You put in your dollar amount within a given time period and it tells you how much it will be worth in that year and how much it was worth in a prior given year.

The first cost is the shoe leather cost. It means that the resources wasted when inflation encourages people to reduce their money holdings. Basically keep out just enough and not to much, make more trips to the bank, which can cause your shoes to wear faster. When there is inflation you want to keep less money than you normally would.

The second is the menu cost; this is the cost of changing prices. Most all companies make the prices and will leave them the same price for a specific time period. I know at UPS we have a rate increase once a year. There is so much to increasing the cost or simply changing the cost of an item, and can become very costly. You have to print new catalogs, price lists, you have to advertise the new price increase. I do know firsthand that when you have a price increase customers do not take to that to kindly.

The third would be Relative price variability. The market economies rely on relative prices to allocate scarce resources. Consumers compare the goods and services and then decide on what to purchase. When consumers are making these decisions, it affects how the scarce factors of production are allocated in companies.

I think that the menu cost if the most important. Most consumers know that once a price is changed as in grocery stores, that the sale price will be on for a week, and the regular price will change possibly two to three times a year. As where ups changes once a year and the customers know this and are ready for the price increase. As where, let’s say if we increase our prices every week, we would be totally out of business. I personally feel that this gives the consumer a safe haven for a specific time period in which they know they can purchase a good for a specific time at a given price.

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