Chapter 20: Financial Aspects of Household and Firm Behavior

Again seems like a repeat chapter

Spending and financing decisions are in theory separate decisions. (from corporate finance) However in reality they generally are not. For example: a firm offers low financing that leads to increased spending or the fed lowers interest rates to do the same. (APV vs NPV)

Household’s Portfolio is composed of real and financial assets

Net worth is merely assets less liabilities

Household spending decisions (and hence their portfolio decisions) are based on many things: income, expected future income, wealth, opportunities--real returns, interest rates. Which is one reason why we track consumer confidence. A confident consumer is more apt to spend.

Real Assets: durables and real estate

Do you want to purchase now or later?

Many things go into the decision: lower discount rate more likely to stay invested. \

Many invest for retirement, large purchases etc. Additionally investors save for education etc. Risk aversion also enters the picture as investors fear being laid off etc. Thus they frequently want to leave some money in cash.

Risk aversion:

Ways to classify risk aversion:

Risk loving

Risk neutral

Risk averse

Generally speaking investors are risk averse. The question is "how risk averse?"

Risk averse people do buy risky assets, but they require a premium to do so.

Issuing securities can finance purchases by individuals or firms. This typically involves debt. For the individual it may mean a bank loan or credit purchases. For firms it may be private or public debt sales.

Think of it as a cash flow statement. All of us have sources and uses of funds. Sources include income and borrowing, uses include consumption and changes in financial (noncash assets)

Demand for real assets is a positive function of income, wealth, and return on real assets.

We saw in last chapter that demand for real money balances is increase function of income, wealth)

Also the demand for real assets is decreasing in interest rates.

The net demand for non-monetary financial assets is increasing in income, wealth, and interest rates and decreasing in return on real assets.

To purchase anything the firm or individual must decide how to finance it. It thus becomes a capital structure question. Should we issue debt or should we issue equity? Or shoud we save up for the purhcase?

The answer to this question is beyond the scope of this class, but it is a function of type of assets, buiness risk, tax policy, and market conditions.

Chapter 21:

Financial Effects of the Government and Foreign Sectors

The government can influence spending in many ways: confidence, interest rate policy, taxes. And their own spending.

Government spending must also be financed. They do not have the option of selling shares so they issue debt.

Government spending – government receipts = net borrowing

For year this grew. In last 2 years it has not.