chapter 20 financial aspects of household and firm behavior ©2000 south-western college publishing
TRANSCRIPT
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Chapter 20Financial Aspects of
Household and Firm Behavior
©2000 South-Western College Publishing
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Portfolio
The collection of real and financial assets and liabilities
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Net WorthNet Worth
The difference between assets and liabilities at a point in time
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Balance Sheet of the Household SectorDecember 31, 2000
Assets Liabilities
Real estate Real estate mortgagesOther real assets Installment debtMoney Other personal debtOther financial
assets Net worthNet worth
Total assets Total assets Total liabilities plus Total liabilities plus net worthnet worth
Exhibit 20 - 1
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Household Portfolio Changes over Time J.P. Young (thousands $)
(1)January 1, 2000
Real Assets $100Money $ 3Other Financial Assets $ 30Total Assets $133Total Liabilities $ 53Net Worth $ 80
Exhibit 20 - 2
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Household Portfolio Changes over Time J.P. Young (thousands $)
(2)Actions During Year
Purchase computer,stereo, TV $5
Increase in money holdings $ .3Acquisition of stocks & bonds $2.7Change in Total Assets $8Change in Total Liabilities $2Change in Net Worth $6
Exhibit 20 - 2 cont.
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Household Portfolio Changes over Time J.P. Young (thousands $)
(3)December 31, 2000
Real Assets $105Money $ 3.3Other Financial Assets $ 32.7Total Assets $141Total Liabilities $ 55Net Worth $ 86
Exhibit 20 - 2 cont.
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Household Asset Accumulation: spending and saving
•Real AssetsReal Assets - durable goods and houses•Financial AssetsFinancial Assets - stocks, bonds, money
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Financial Liabilities
Debt incurred by borrowing
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Borrowing Constraint
The impediment to continuous borrowing that may come from the lender’s unwillingness to keep lending or the borrower’s unwillingness to keep borrowing
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Hou
seh
old
Por
tfol
io C
hoi
ces
Households accumulates real and financial assets and liabilities in an attempt to
maximize their well-being.
Changes and expected changes in income, wealth, and interest rates change the economic and financial environment.
In response to the changing environment, households change their desired portfolios
of assets and liabilities
Households will spend more or less and accumulate more or less real and financial assets and liabilities in an attempt to reach
their desired portfolios.Exhibit 20-3
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Flow of Funds
A social accounting system that divides the economy into sectors and constructs a sources and uses of funds statement for each sector
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Sources and Uses of Funds Statement
A statement for each sector of the economy, such as the household, firm, government, or foreign sectors, that lists its sources and uses of funds...
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The Sources and Uses of Funds for Households
Sources of FundsSources of Funds Uses of FundsUses of Funds
Disposable income Consumption spending + borrowing = nondurables and services
+ Consumption spending on durables and investment spending on houses
(changes in real assets held)
+ Changes in financial
assets held(Eq. 20 - 1)
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Subtract borrowing from both sides of equation:
Sources of FundsSources of Funds Uses of FundsUses of Funds
Disposable income = Consumption spending nondurables and services + Consumption spending on durables and investment spending on houses
(changes in real assets held)
+ Net Changes in financial assets held(Eq. 20 - 2)
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What isnet financial investment?
The increase in net financial assets
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Y = Household disposable incomeW = Household wealth or net worthr = The yield or return on real assets; the sum of the value of the flow of services from real assets plus any capital gain, all divided by the price of the real asseti = The market interest rate (return) on financial assets
+ + + –•Demand for Real Assets = f(Y, W, r, i)•Demand for Real + + –
Money Balances = f(Y, W, i)•Net Demand for Nonmonetary + + + –
Financial Assets = f(Y, W, r, i)
(Eq. 20 - 3, 4, 5)
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Household Demand for Real & Financial Assets
Increase i
•Increase net demand for nonmonetary financial assets•Decrease demand for real assets•Decreases demand for real money balances
Increase Y or W
•Increase net demand for nonmonetary financial assets•Increase demand for real assets•Increase demand for real money balances
•Decrease net demand for nonmonetary financial assets•Increase demand for real assets
Increase r
Exhibit 20 - 4
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Marginal RevenueThe additional revenue from selling an additional unit of output
Marginal Cost
The additional cost of selling an additional unit of output
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Investment Spending
For businesses, spending on new equipment and capital or net additions to inventories
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AssetsAssets LiabilitiesLiabilities
Real Assets EquityCapital Goods Common StockInventories
Financial Assets DebtCurrency, checkable deposits Long-termMoney Market Mutual Funds Short-termCD’sMutual FundsTrade CreditOther Financial Assets Other Financial Liabilities
Total Assets Total Liabilities plus Net Worth
The Balance Sheet of the Business Sector
Exhibit 20 - 5
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Net Investment
Gross investment minus depreciation
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23Exhibit 20-6
Business Investment
To replace worn out or obsolete capital (plant,
equipment, and machinery)
To increase the capital stock
(plant, equipment, and
machinery)
To add to inventories (raw materials, goods
in process, finished goods)
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Opportunity Cost
The return one could have earned by using funds in the next best alternative; for investment spending, the real interest rate
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Internal Financing
The spending of money balances on hand or the liquidation of financial or real assets to finance spending that exceeds current receipts
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External Financing
Financing spending that exceeds current receipts by expanding either debt or equity
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Business Finance
Financing Need
Internal
Retained Earnings
External
Equity Debt
Short-Term Debt
Long-Term Debt
Exhibit 20 -7
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A firm’s balance sheet can be summarized as follows:
(20-6) A = L + NW
(20-7) A = L + NW
(20-8) L = A – RE
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Corporate Financing Gap
The increase in a firm’s liability, which is equal to the increase in assets held minus retained earnings
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Leverage Ratio
The ratio of debt to equity on a firm’s balance sheet
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Sources of Funds Uses of Funds
Net Revenues +
Borrowing = Net Spending on real assets such as plant and equipment
+ Net Spending on real assets
such as inventories
+ Changes in financial assets held
Sources And Uses Of Fund For Sources And Uses Of Fund For The Business SectorThe Business Sector
(Eq. 20-9)
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Sources of Funds Uses of Funds
Net revenues +
Net borrowing = Net spending on real assets such as plant
and equipment
+ Net spending on real assets such as inventories
Subtract the “changes in other financial assets held”
from both sides of Equation:
Eq. (20-10)