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By Carlos M. Peláez, Carlos A. Peláez (auth.)

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There are three types of agents in the economy. First, the entrepreneur has skills in developing a project. The project requires investment now and will deliver high returns in the distant future. In the framework of cost/benefit analysis of the appendix to Chapter 1, the project has positive and significant present value, which means that the cash flows of the projects exceed the costs and is superior to investment in an alternative paying the riskless interest rate. That is, the project is valuable because its future cash flows net of cost in the horizon of investment exceed the interest payments derived from an investment paying interest without risk.

The consequence of this interaction of financial intermediation with the channels of growth is economic growth itself. 63 Agents would be able to find optimum investment opportunities for their savings. Under uncertainty, there would still not be need for financial intermediaries because markets would develop that would provide liquidity in one time period in exchange for payment in a future time period. 2 Functions of financial intermediation I. Permitting Economies of Scale ● Transforming securities from bonds and stocks into demand or savings deposits ● Mobilizing savings { Pooling multiple small funds of investors into the financing of large projects ● Facilitating risk management { Pooling concentrated risks into diversified risk instruments for smaller investors { Transferring/trading risks, permitting larger projects that diversify risks among many institutions ● Allocating resources { Facilitating intertemporal allocation: financing presently directly productive activities with long gestation/high return for future repayment „ Creating liquid markets to securitize directly productive activities „ Converting long-term, large-scale project financing into short-term liquidity for small investors { Screening risks of large projects, providing information at low cost ● Reducing transaction costs { Facilitating vertical integration to reduce transaction costs II.

Legislatures approve regulation when there is high interest in the issue, typically after crises. The declining interest after crisis resolution moves attention to other more current affairs. 37 Growth and exogenous shocks cause administrative failures when legislative monitoring is costly and ineffective. 38 The maximization of utility or self-interest by the politician derives from the typical marginal conditions of price theory, allocating benefits across groups. There need not be pure producer protection if consumers can provide votes or money.

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