Assignment 3 - 4

Q1.
Forward theory of looking of consumptions:
Introduction:
The Forward Theory of Looking at Consumptions is idea in economic studies. It talks about
how people make choices on spending their money. This theory say people do not just think
of now but also think of future when they spend. Basic Concepts
Future Expectations: People think about what might happen in future. This affect how
they use money today. If people think they will have more money in future, they might
spend more today. If they think future is uncertain, they might save more.
Income and Savings: How much money people make now and in future changes their
spending. People who earn more usually spend more. But they also save money for future.
Consumption Smoothing: This means people try to keep their spending smooth over
time. They do not want to spend too much now and too little later. They try to balance
spending and saving.
Interest Rates: When interest rates are high, people might save more because they get
more return on savings. When interest rates are low, people might spend more because
saving gives less return.
How Forward Theory Works

Decision Making: People look at their current money and guess future money. They
decide how much to spend and save based on this.
Risk and Uncertainty: If future is risky, people save more to be safe. If future looks
stable, people spend more freely.
Life Stages: Young people may spend more on education and fun. Middle-aged people
may save for house and kids. Old people spend savings for retirement.
Economic Policies: Government policies like taxes, interest rates, and social security
affect how people think about future and make spending choices.
Example:
Consider a young worker who just started a job. He earns $2000 per month. He expects his
salary to increase to $3000 per month in 5 years. He decides to save $500 every month now.
When his salary increases, he plans to save $1000 per month. He is using Forward Theory to
balance his spending and saving over time.
Q1. Real Interest Rates, Consumption, Savings, Investments,
Financial System, and the Supply of Saving:
Introduction
This assignment talks about important economic concepts: Real Interest Rates,
Consumption, Savings, Investments, Financial System, and the Supply of
Saving. These ideas help understand how people and businesses use money in
economy.
Real Interest Rates
 Definition: Real interest rate is the interest rate adjusted for inflation. It shows the
true cost of borrowing money and the true return on savings.
 Importance: Real interest rates affect how people decide to save or borrow. High
real interest rates encourage saving because people get more return. Low real
interest rates encourage borrowing because it costs less to borrow money.
Consumption
 Definition: Consumption is the use of goods and services by households. It includes

things like food, clothes, rent, and entertainment.
 Factors Affecting Consumption: Income, future expectations, interest rates, and
consumer confidence affect how much people consume.
 Role in Economy: High consumption usually means a strong economy because
businesses sell more. Low consumption can signal economic problems.
Savings
 Definition: Savings is the part of income not spent on consumption. People save
money in banks, stocks, or other investments.
 Reasons for Saving: People save for future needs, emergencies, retirement, and big
purchases like a house or car.
 Impact on Economy: Savings provide funds for investments. More savings can lead
to more economic growth if these savings are used for productive investments.
Investments
 Definition: Investments are the purchase of goods that are not consumed today but
used to create future wealth. Examples include buying machinery, buildings, or
stocks.
 Types of Investments: There are business investments (like factories) and financial
investments (like stocks and bonds).
 Influence of Interest Rates: Low interest rates can lead to more investments
because borrowing money is cheaper. High interest rates can reduce investments
because borrowing is expensive.
Financial System
 Definition: Financial system is the system that allows money to move between
savers and borrowers. It includes banks, stock markets, and other financial
institutions.
 Functions: The financial system provides loans for businesses, helps people save and
invest money, and manages risks.
 Importance: A strong financial system supports economic growth by making it easier
to borrow and save money.
The Supply of Saving
 Definition: The supply of saving is the amount of money people are willing to save at
different interest rates.
 Factors Affecting Supply of Saving: Income levels, interest rates, and economic
conditions affect how much people save.
 Role in Economy: The supply of saving provides the funds needed for investments.
High supply of saving can lower interest rates, making borrowing cheaper and
encouraging investments.
Q1. Financial crisis 2006 to 2007
The global financial crisis of 2007–2008, commonly referred to as the Great Recession or the
Global Financial Crisis (GFC), was a serious global economic catastrophe. Many analysts
believe that it was the worst financial catastrophe since the Great Depression (1929). The
crisis started in 2007 when the US subprime mortgage market saw a decline. It intensified
into a major global banking crisis on September 15, 2008, when investment bank Lehman
Brothers collapsed.
Key Causes of the Financial Crisis
1. Subprime mortgages and the housing bubble:

 A housing bubble was created in the early 2000s when there was a sharp rise in
property prices.
 Assuming home values will rise and allow borrowers to refinance their loans, lenders
extended subprime mortgages to people with bad credit histories.
2. Financial Innovation and Securitization:
 These subprime mortgages were packaged by banks into collateralized debt
obligations (CDOs) and mortgage-backed securities (MBS), which they then sold to
investors around the world.
 Despite the inherent hazards, credit rating organizations frequently gave these
products high ratings.
3. High-Risk, High-Leverage Investments:
 Financial institutions borrowed substantial sums of money to invest in MBS and CDOs,
greatly increasing their leverage.
 The employment of intricate financial products, such credit default swaps (CDS),
increased systemic risk and interdependence.
4. Regulatory Errors:
 Uncertainty in the financial markets and insufficient regulatory monitoring made it
possible for dangerous lending and investing practices to spread widely.
 The problem was made worse by the lack of strict regulatory oversight of important
financial institutions.
Chronology of the Crisis
1. Early Warning Signs and the Subprime Mortgage Crisis, 2006–2007:

 Home prices peaked and started to fall in 2006, which increased the number of
mortgage delinquencies and foreclosures.
 The subprime mortgage crisis was made clear by the bankruptcy filings of significant
subprime mortgage lenders by 2007.
2. 2007–2008: Financial Panic and Escalation:

 A liquidity crisis resulted in the interbank lending market seizing up in 2007 because of
doubts about the worth of MBS and CDOs.
 A significant investment bank called Bear Stearns failed in March 2008 and was bought
by JPMorgan Chase with government assistance.
 The bankruptcy of Lehman Brothers in September 2008 marked the apex of the crisis
and sent shockwaves through the world's financial markets.
3. 2008–2009: Recession and Government Interventions:
 Globally, governments and central banks implemented previously unheard-of
measures to stabilize the financial system, such as significant monetary easing and the
rescue of important financial firms.
 The Troubled Asset Relief Program (TARP) was passed by the US government in an
effort to boost bank capital and rebuild public trust.
 A severe worldwide economic slowdown brought about by the crisis resulted in
notable drops in output, employment, and trade.
Consequences of the Crisis
1. Recession in the Economy:

 The Great Recession, which saw sharp drops in economic activity, high unemployment
rates, and a decrease in consumer spending, was caused by the financial crisis.
 Many nations went through protracted phases of weak economic growth.
2. Bailouts and bank failures:
 A great deal of financial organizations needed government bailouts to survive,
otherwise they failed.
 Major banks, insurers (such as AIG), and automakers (such as General Motors) were
among them.
3. Reforms in Regulation:
 Governments enacted regulatory changes in the wake of the crisis to improve financial
control and stop a repeat of the situation.
 The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in the
US in 2010 in an effort to tighten regulations on the financial sector.
4. Impact on the Economy Over Time:
 Long-term consequences of the crisis on the world economy included rising public
debt, adjustments to monetary policy, and alterations in the balance of economic
power.
 Additionally, it brought financial practices under closer examination and brought
consumer protection and financial stability back into the forefront.

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Assignment 3 - 4

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Q1.

Forward theory of looking of consumptions:

How Forward Theory Works

Real Interest Rates

 Definition: Consumption is the use of goods and services by households. It includes

The Supply of Saving

1. Subprime mortgages and the housing bubble:

1. Early Warning Signs and the Subprime Mortgage Crisis, 2006–2007:

2. 2007–2008: Financial Panic and Escalation:

Consequences of the Crisis

1. Recession in the Economy:

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