The most important borrower-spenders are businesses and the government (particularly the federal government), but households and foreigners also borrow to finance their purchases of cars, furniture, and houses. The arrows show that funds flow from lender-savers to borrower-spenders via two routes. In direct finance (the route at the bottom of Figure 1), borrowers borrow funds directly from lenders in financial markets by selling them securities (also called financial instruments), which are claims on the borrower’s future income or assets. Securities are assets for the person who buys them but liabilities (IOUs or debts) for the individual or firm that sells (issues) them. For example, if General Motors needs to borrow funds to pay for a new factory to manufacture electric cars, it might borrow the funds from savers by selling them bonds, debt securities that promise to make payments periodically for a specified period of time. Why is this channeling of funds from savers to spenders so important to the economy? The answer is that the people who save are frequently not the same people who have profitable investment opportunities available to them, the entrepreneurs. Let’s first think about this on a personal level. Suppose that you have saved $1,000 this year, but no borrowing or lending is possible because there are no financial markets. If you do not have an investment opportunity that will permit you to earn income with your savings, you will just hold on to the $1,000 and will earn no interest. However, Carl the Carpenter has a productive use for your $1,000: He can use it to purchase a new tool that will shorten the time it takes him to build a house, thereby earning an extra $200 per year. If you could get in touch with Carl, you could lend him the $1,000 at a rental fee (interest) of $100 per year, and both of you would be better off. You would earn $100 per year on your $1,000, instead of the zero amount that you would earn otherwise, while Carl would earn $100 more income per year (the $200 extra earnings per year minus the $100 rental fee for the use of the funds). In the absence of financial markets, you and Carl the Carpenter might never get together. Without financial markets, it is hard to transfer funds from a person who has no investment opportunities to one who has them; you would both be stuck with the status quo, and both of you would be worse off. Financial markets are thus essential to promoting economic efficiency. The existence of financial markets is also beneficial even if someone borrows for a purpose other than increasing production in a business. Say that you are recently married, have a good job, and want to buy a house. You earn a good salary, but because you have just started to work, you have not yet saved much. Over time, you would have no problem saving enough to buy the house of your dreams, but by then you would be too old to get full enjoyment from it. Without financial markets, you are stuck; you cannot buy the house and must continue to live in your tiny apartment. If a financial market were set up so that people who had built up savings could lend you the funds to buy the house, you would be more than happy to pay them some interest in order to own a home while you are still young enough to enjoy it. Then, over time, you would pay back your loan. The overall outcome would be such that you would be better off, as would the persons who made you the loan. They would now earn some interest, whereas they would not if the financial market did not exist. Now we can see why financial markets have such an important function in the economy. They allow funds to move from people who lack productive investment opportunities to people who have such opportunities. Thus financial markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy. Indeed, as we will explore in Chapter 8, when financial markets break down during financial crises, as they have in Mexico, East Asia, and Argentina in recent years, severe economic hardship results, which can even lead to dangerous political instability. Well-functioning financial markets also directly improve the well-being of consumers by allowing them to time their purchases better. They provide funds to young people to buy what they need and can eventually afford without forcing them to wait until they have saved up the entire purchase price. Financial markets that are operating efficiently improve the economic welfare of everyone in the society.
Related Articles on Marketing
- Marketing
by Lance Williams
Marketing, is "an organizational function and a set of processes for creating, communicating and del... - Aggregate Output and Income
by James
The most commonly reported measure of aggregate output, the gross domestic product (GDP), is the mar... - Financial Markets
by James
Financial markets perform the essential economic function of channeling funds from households, firms... - Debt and Equity Markets
by James
Now that we understand the basic function of financial markets, let’s look at their structure. The f... - The New Marketing Hotsheet
by James
The task of getting your site high rank in the search engine is very tricky task. It requires hard w... - Main Reasons- Why people buy & sell Ebooks?
by Sunita meena
So, where have all the regular books gone? Well, there’ll still around, if you didn’t notice, but th... - Useful Strategies on How to Sell Your EBooks
by Amitt Sharmaa
EBook is the buzzword of today and it is fast becoming a potential marketing tool for your products ... - Business To Business Marketing: Attracting Business Customers Online
by Nazeer Daud
As a business to business marketer, many of the tactics that work in B2C marketing simply won’t cut ... - How can you get Your Articles Spreading All Around to get You Hundreds of Visitors Daily
by RUPINDER KAUR
What if I showed you some simple ways and tactics that will help you to generate more traffic from y... - Valuable plans on how to sell your Ebooks!
by pardeep kumar
Ebook is the buzzword of these days and it is high-speed becoming a potential marketing tool for you... - Internet marketing success with Ebooks!
by inderpreet
Ebooks have become a very general commodity on the Internet. You can now download Ebooks from lots o... - Message Steal this E-Book!
by BABA TarsemSingh
Paper books like that one were not easy to steal, because of the guards in the bookstores and the co... - Should I Write A Free EBook?
by JAGJEET
Well, I have a website/blog/brochure/business card, you say. And that's a good thing. You should. Th... - Getting Into the Market
by Kaye Z. Marks
One of the biggest jobs for the new business owner is getting your name out on the marketplace. Give... - How Writing and Submitting Articles is The Best Way to Promote Your Business and Earn Money?
by Vishal Gulati
If you want to earn money online, your online business needs traffic. Among all the various ways of ... - The Unstoppable Viral EBook - Creating And Promoting Kingkong
by Max john
Ebooks are more popular now than ever and with so many people deciding to enter the World Wide Web, ... - Three important Facts about Viral Ebooks
by Max john
It is a well-known fact that free eBooks are one of the best weapons in a viral marketing campaign a... - What are the Benefits of Having an EBook
by Max john
When it comes to having success on the internet, there are a plethora of things you can do to furthe... - The E-book Fairytale
by Max john
Junk. There’s a lot of it out there, and you had better be prepared to fall over your fair share of ... - What is the Best Content for Your EBook
by Max john
Internet experts all agree, for real Internet success and to make serious money online, you need to ...
