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Chapter 21: Problem 2

How does the financial system-both financial markets and financial intermediaries-provide risk sharing, liquidity, and information to savers and borrowers?

Short Answer

Expert verified
The financial system, composed of financial markets and intermediaries, provides risk sharing, liquidity and information. Risk sharing is provided through diversified investments via financial markets and intermediaries. Liquidity is offered by markets allowing fast asset trading and intermediaries like banks facilitating efficient money management. Information availability, vital for decision-making, comes from financial market price signals and research conducted by financial intermediaries.

Step by step solution

01

Understanding Financial Systems and their roles

Financial systems provide a means for individuals, businesses, and governments to efficiently manage their money, allocate resources, and coordinate their economic activity. They consist of financial markets and financial intermediaries, both of which play different roles in providing risk sharing, liquidity and information.
02

Detailed look into the role of risk sharing

Financial systems provide risk sharing by allowing savers to diversify their investments. By investing in various assets through financial markets, or depositing money with different financial intermediaries, savers can spread their risk. Similarly, borrowers can gain access to credit from a diverse array of lenders, decreasing their dependency on a single source of funds.
03

How does financial system provide liquidity?

Liquidity is another crucial service that financial systems offer. Financial markets like stock markets or Forex provide a platform for trading assets, meaning savers can quickly convert their assets into cash. Financial intermediaries, particularly banks, are also fundamental to providing liquidity in the system. They accept deposits and provide loans, channelling funds from savers to borrowers.
04

Information provision and its importance

Finally, the financial system plays a vital role in providing information. Prices in financial markets act as signals, helping both savers and borrowers to make decisions based on supply and demand. On the other hand, financial intermediaries - such as investment banks or advising firms - conduct research and provide advice to their clients, serving as an essential source of information.

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Most popular questions from this chapter

The Apply the Concept claims that Ebenezer Scrooge promoted economic growth more when he was a miser and saved most of his income than when he reformed and began spending freely. Suppose, though, that after he reformed, he spent most of his income buying food for the Cratchits and other poor families. Many economists believe that there is a close connection between how much very poor people eat and how much they are able to work and how productive they are while working. Does this fact affect the conclusion about whether the pre- reform or postreform Scrooge had a more positive impact on economic growth? Briefly explain.

According to an article in the Wall Street Journal, Federal Reserve Chair Janet Yellen stated that unless obstacles to some women working in the paid labor force are removed, the United States will "incur a substantial loss to the productive capacity of our economy." Ms. Yellen also stated that more women in the labor force would "help overcome long-term challenges such as an aging population and slow productivity growth." a. What measure do economists use for the productive capacity of the economy? b. Why might an aging labor force and slow productivity growth pose long-term challenges to the U.S. economy? How might more women working in the paid labor force help overcome these challenges?

What are loanable funds? Why do businesses demand loanable funds? Why do households supply loanable funds?

Firms care about their after-tax rate of return on investment projects. In the market for loanable funds, draw a graph and explain the effect of an increase in taxes on business profits. (For simplicity, assume no change in the federal budget deficit or budget surplus.) What happens to the equilibrium real interest rate and the quantity of loanable funds? What will be the effect on the level of investment by firms and the economy's capital stock in the future?

(Related to Solved Problem 21.1 on page 709 ) An article in the Wall Street Journal noted that "raising productivity in the long run is the most effective way to elevate standards of living." Do you agree? Briefly explain.
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