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Summary Economics 144 - The Economy CORE unit 10
Detailed summary based on unit 10 of The Economy CORE textbook. Analysis includes in-depth explanation using graphs.
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UNIT 10 – BANKS, MONEY AND THE CREDIT MARKET§ Markets for goods and services allow parties to interact in mutually beneficial
ways (units 6-9)
§ People can rearrange the timing of their spending by borrowing, lending,
investing and saving
§ Principal-agent relationship of borrowing and lending – lenders often require
borrowers to contribute some of their own funds (lack of enforceable contract)
§ In most markets, money is the medium of exchange (bank notes, bank deposits)
§ The role of commercial banks and the central bank in the economy
§ Banks are profit-maximizing firms that create money in the form of bank deposits
in the process of supplying credit
§ Nation’s central bank creates legal tender and lends to banks at its chosen policy
interest rate
10.1 MONEY AND WEALTH
Money
• Money = a medium of exchange used to purchase goods or services
Þ Bank notes, bank deposits, cheques etc. (accepted payment)
• Money allows purchasing power to be transferred among people
• For money to do its work, everyone else must trust that others will accept your
money as payment – government and banks usually provide this trust
Income and wealth
• Wealth = stock of things owned or value of that stock
Þ Buildings + land + machinery + capital goods + financial assets – debt owed
+ debt owed to you
Þ The accumulation of past and current savings
• Human capital = wealth and immaterial aspects like health, skills, ability to earn
an income (broader definition than material wealth)
• Income = the amount of money one receives over some period of time (flow)
Þ From market earnings, investments, government
Þ i.e. interest, profit, rent, labour earnings and other payments less taxes paid
Þ after-tax income = disposable income
Important concepts
• Depreciation = reduction in the value of a stock of wealth over time that occurs
through use (wear and tear) or obsolescence
• Net income = the maximum amount that one could consumer without running
down wealth
Þ Net income = gross income – depreciation
,• Earnings = wages, salaries and other income from labour
• Consumption = expenditure on consumer goods (short-lived and long-
lived/durable goods or services)
• Savings = income that is not consumed, when consumption expenditure is less
than net income and wealth increases
• Investment = expenditure on newly produced capital goods e.g. machinery or
buildings
• Saving serves as financing for investments
• Only the corporate sector has really been saving in SA
• SA is highly dependent on foreign investment
10.2 BORROWING: BRINGING CONSUMPTION FORWARD IN TIME
Consumption over time
• There is a trade-off between consuming goods now and later
• The opportunity cost of having more goods now, is having fewer goods later
Borrowing and lending
• Borrowing and lending allows us to reorganize over time our capacity to buy
goods and services
• Borrowing allows us to buy more now, at a cost of buying less in future
• Interest rate (r) = the price of bringing some buying power forward in time
!"#$%&"'(
Þ Interest rate = #!)'*)#$+
-1
• Repayment = principal + interest
• (1 + r) = tradeoff between current and future consumption (MRT) *unit 3
, Repayment = principal + interest
= 91 + 91r
= 91(1 + r)
= $100
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