Financial System People have virtually unlimited needs, but the economic resources to supply those needs are limited. Therefore, the greatest benefit of an economy is to provide th

Financial System

People have virtually unlimited needs, but the economic resources to supply those needs are limited. Therefore, the greatest benefit of an economy is to provide the most desirable consumer goods and services in the most desirable amounts - what is known as the efficient allocation of economic resources. To produce these consumer goods and services requires capital in the form of labor, land, capital goods used to produce a desired product or service, and entrepreneurial ability to use these resources together to the greatest efficiency in producing what consumers want most. Real capital consists of the land, labor, tools and machinery, and entrepreneurial ability to produce consumer goods and services, and to acquire real capital costs money.

The financial system of an economy provides the means to collect money from the people who have it and distribute it to those who can use it best. Hence, the efficient allocation of economic resources is achieved by a financial system that allocates money to those people and for those purposes that will yield the greatest return.

The financial system is composed of the products and services provided by financial institutions, which include banks, insurance companies, pension funds, organized exchanges, and the many other companies that serve to facilitate economic transactions. Virtually all economic transactions are effected by one or more of these financial institutions. They create financial instruments, such as stocks and bonds, pay interest on deposits, lend money to creditworthy borrowers, and create and maintain the payment systems of modern economies.

These financial products and services are basedon the following fundamental objectives of any modern financial system:

• to provide a payment system;
• to give money time value;
• to offer products and services to reduce financial risk or to compensate risk-taking for desirableobjectives;
• to collect and disperse information that allows the most efficient allocation of economic resources;
• to create and maintain financial markets that provide prices, which indicates how well investments are performing, which also determines the subsequent allocation of resources, and to maintain economic stability.

Available at: <http://thismatter.com/money/banking/ financial-system.htm>. Retrieved on: July 27th, 2015. Adapted.

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