Question

1- Why do economists worry more about the collapse of the finical sector than other sectors?

2- Explain what herding and leverage are and how they can lead to bubble. Also, explain why leverage can cause the bursting of a bubble to be worse than it otherwise would be?

3- How was the great depression different from the find crisis of 2008 and 2009?

4- How did the fed respond to the financial cric in 2008? How did the federal government respond?

5- What is the law of diminishing control?

6- Explain the principle of comparative advantage. Does it tell vs how the gains from trade will be distributed?

7- Why is the financial sector important in more economic debates? Why are more economists concerned with the total amount of flows coming out of retiring to spending?

8- What is money? What is a liquid financial asset? Why do people hold their assets in form of money?

9- The major measures of money are M1 and M2 what are the major components of each of these measures? Why do economists focus their attention on M2?

10- Explain how banks create money. Compare the effect on the money supply of accepting a cash deposit with that of making a loan?

Answer 1

The financial sector is the sector that links the lenders of the economy with the borrowers. It is at the core of the economy and has a direct link with each component of aggregate demand. Aggregate Demand with has four components namely private consumption, private investment, government, and net exports. We can study the links of these with the financial sector:

1) Private consumption: the financial sector facilitates the household that to save and lend their savings in a bid to earn income over the saved money. Changes in the interest rate determine the saving behavior of the household and thus dictate the private consumption patters to an extent. Higher interest rates lead households to save more and thus supply greater funds to in the loan market.

2) private investment: the private corporate sector depends directly on the financial bsector to finance their investment projects and thus any changes in the financial sector has direct and strong effect on investment.

3) government: Government looks towards financial sector for deficit financing i.e., financing expenditure over tax revenue, (G-T).

4) Net exports: the changes in the financial sector directly affects the external sector through changes in demand for exports and imports.

Thus the financial sector directly affects the aggregate demand in the economy which determines the equilibrium income/output level and stability of the economy. A weak financial sector not able to absorb shocks from the global economy will lead to a fall of the economy.  

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