[ECON 101 WRITE UP] TOPIC 2_ Financial Market & IS-LM Model.pdf

University of the Philippines, Diliman Extension Program in Pampanga [Econ 101] 2.1 FINANCIAL MARKET & 2.2 IS-LM MODEL PRESENTED BY: STACEY MIRANDA & ROSE JEBULAN PROF. BURT GALANG...

University of the Philippines, Diliman Extension Program in Pampanga [Econ 101] 2.1 FINANCIAL MARKET & 2.2 IS-LM MODEL PRESENTED BY: STACEY MIRANDA & ROSE JEBULAN PROF. BURT GALANG Saving - The portion of after-tax income not spent on consumption. MONEY Money - A liquid asset used for transactions Investment - The purchase of new capital that does not earn interest. goods (e.g., machinery, buildings). TYPES OF MONEY ○ Coins - A medium of exchange Financial Investment - The purchase of for goods and services. financial assets like stocks or bonds. ○ Checkable Deposits - Demand deposit accounts that Money Market Funds - Investment funds that allow checks or drafts to be invest in short-term, high-quality financial written. assets. Wealth - The total value of all assets owned by Demand for Money - The total amount of an individual. money that people and firms want to hold for transactions. Bonds - Financial assets that pay interest but are not used for transactions. Nominal Income - Total income measured in current dollars, without adjusting for inflation. Interest Rate - The percentage of interest paid on bonds, determining the return on investment Decreasing Function of the Interest Rate - from holding bonds. A function showing how the demand for money decreases as the interest rate increases. Transaction Costs - The costs associated with buying or selling bonds, such as broker fees. Transaction Level - The total volume of economic transactions, which is proportional to Level of Transactions - The amount of money nominal income. needed for daily expenditures. Real Income - Income adjusted for inflation, Income - Earnings received over a period of measuring the purchasing power of income. time from work, interest, and dividends. Equilibrium in Financial Markets - The ○ Daily Cash Flow condition where the supply of money equals the Management - Handling cash demand for money. inflows and outflows. ○ Interbank Transactions - Central Bank Balance Sheet - A financial Settling transactions between statement showing the central bank's assets banks. (bonds) and liabilities (money supply). ○ Regulatory Requirements - Meeting central bank-mandated Expansionary Open Market Operation - reserve requirements. When the central bank buys bonds, increasing Loans - Amounts of money lent by banks to the money supply, raising bond prices, and individuals and firms, a significant portion of lowering interest rates. bank assets. Contractionary Open Market Operation - Bonds - Financial assets purchased by banks, When the central bank sells bonds, decreasing representing investments in debt securities. the money supply, lowering bond prices, and increasing interest rates. Zero Lower Bound - The situation where interest rates approach zero and cannot be Financial Intermediaries - Institutions that lowered further, making traditional monetary collect funds from individuals and firms to invest policy ineffective. in financial assets or make loans. Liquidity Trap - At the zero lower bound, monetary policy may become ineffective even Balance Sheet of Banks - A financial with increases in the money supply because statement showing a bank's assets and interest rates cannot be further reduced. liabilities. AGGREGATE DEMAND AND AGGREGATE Checkable Deposits - Funds in bank accounts SUPPLY accessible by checks, debit cards, or withdrawals. Aggregate Demand (AD) - The total amount of goods and services Reserves - Funds held by banks to manage that households, businesses, and the daily fluctuations, interbank transactions, and government in an economy are willing meet regulatory requirements. to buy at different price levels. Three Main Purposes: Example: If concert tickets decrease in price from ₱1,400 to ₱200, the demand for those tickets would rise, showing increased aggregate demand. Keynesian Cross - A model showing the relationship Y = C + I + G + Nx between total spending (aggregate demand) and total output (national Aggregate Supply (AS) income). - The total amount of goods and services that producers in an economy are willing to make and sell at different price levels. Example: If the price of potatoes rises, your mom may buy fewer potatoes, which reduces the overall supply of meals she can make at home. KEYNESIAN CROSS Invisible Hand - The idea that the economy will self-correct over time, with supply and IS-LM MODEL demand meeting at an equilibrium without IS-LM Model government intervention. - Explains the relationship between interest rates (r) and output (GDP), Example: If there’s too much supply, producers specifically on what drives aggregate will reduce output; if demand is high, they will demand. It integrates the goods market increase production to meet it. (IS curve) and money market (LM curve). Keynesian Economics - Challenges classical economics, arguing that government IS Curve (Investment-Savings) - Shows the intervention is necessary during times of relationship between the interest rate and the economic uncertainty or recession to help the output (income) in the goods market. economy recover. Multiplier Effect - Initial government spending circulates through the economy, where households spend one part and save the other. Businesses, seeing fewer customers, may lay off workers, leading to higher unemployment. Lower interest rates (e.g., 2%) lead to increased borrowing for investments and consumer spending. References: Higher interest rates (e.g., 6%) lead to reduced Blanchard, O. (2011). Macroeconomics, XTH borrowing and less spending. Edition. Boston, MA: Pearson Education, Inc. https://drive.google.com/file/d/1L_tVsQCcQV0qI LM Curve (Liquidity Preference-Money VMc6ROWe22R7n7vycY2/view?usp=drivesdk Supply) - Represents the equilibrium in the money market. Keynesian Economics and Deficit Spending with Jacob Clifford. (n.d.). Www.youtube.com. Higher GDP increases the demand for money for https://youtu.be/xKGtmzLP8gw transactions. The central bank controls the money supply, which affects interest rates. ‌ Liquidity Preference - The desire to hold money rather than invest, especially when interest rates are high. Equilibrium in IS-LM Model - The point where the goods market (IS curve) and the money market (LM curve) meet, determining the economy's equilibrium GDP and interest rate.