Econ 212 HW 10
In which of the following cases will the credit supply curve shift to the left?
Changes in the saving motives of households lead to shifts in the credit supply curve. If households start to predict economic hard times ahead, they will save more because they want to build up a store of wealth to be better prepared. This shifts the credit supply curve to the right. Conversely, the credit supply curve will shift to the left if households expect an economic upturn ahead. Changes in the saving motives of firms also lead to shifts in the credit supply curve. Firms pay shareholder dividends out of their profits. But, firms sometimes retain these profits, depositing them in their bank account and saving them for future investments. When firms are nervous about their ability to fund their business activities in the future, they tend to hold on to more retained profits instead of paying them out as dividends. This shifts the credit supply curve to theright, another form of saving for a rainy day. Conversely, when firms increase dividend payments to their shareholders, the credit supply curve would shift to the left. - firms increase dividend payments to their shareholders - households expect an economic upturn ahead
The charging of interest (encourages/discourages) savers to lend their excess money to borrowers as compensation for risk. Therefore, the credit market can (improve/hinder) the allocation of resources in the economy. A downside of charging interest could be the (increased/decreased) accumulation of the overall money supply by lenders.
Credit markets play an extremely valuable social role. By enabling savers to lend their excess money to borrowers, the credit market improves the allocation of resources in the economy. Without credit markets, many new business opportunities and valuable commodities would not be introduced because entrepreneurs would not be able to raise the necessary funds. Over time, however, the charging of interest by lenders allows them to accumulate a larger share of the money supply. - encourages; improve; increases
Japan has been observing a demographic trend of rapid aging. More and more households are approaching the age of retirement which is affecting their saving rate, which in turn is affecting the credit supply in the economy. Suppose the Japanese government now decides to increase taxes on profits. This affects the credit demand in the economy. The adjacent diagram shows the initial equilibrium in the Japanese economy with CD1 and CS1 depicting the initial credit demand and the initial credit supply curves respectively. Assume that the credit demand and the credit supply curves shift by equal amounts, i.e., by the same vertical distance. Using the line drawing tool, draw the new credit supply and credit demand curves in the economy and label them accordingly. The new real interest rate is (greater than/the same as/lower than) its initial equilibrium level. The new quantity of credit is (lower than/greater than/the same as) its initial equilibrium level.
Demographic trends can change the saving behavior of households. As Japanese households approach the age of retirement, their saving rate would rise. This would shift the credit supply curve to the right. The Japanese government's policy of increasing taxes on profits makes investments less attractive as the investors would now earn lower profits on the same level of investment. This would shift the market credit demand curve to the left. Since we are told that the credit demand and credit supply curves shift by equalamounts, the new equilibrium point would be directly below the initial equilibrium point. therefore, the new real interest rate is now lower than its initial equilibrium level. The new quantity of credit is the same as its initial equilibrium level.
Firms, households, and governments use the credit market for borrowing. The credit demand curve shows the relationship between the quantity of credit demanded and the real interest rate. The credit demand curve slopes downward because ____________.
a higher real interest rate reduces a borrowing firm's profit and hence its willingness to borrow
what is deposit insurance
a program implemented in most countries to protect ban depositors, in full or in part, from losses caused by a bank's inability to pay its withdrawal
Actions of the newly elected head of state make citizens feel pessimistic about the future.
changes in household preferences or expectations can cause the demand curve to shift. if households become pessimistic about the future due to the actions of the newly elected head of state, then they will cut their desired borrowing at each interest rate, shifting the market credit demand curve to the left. therefore, the economy is likely to shift to point E
the two basic types of financial capital are
credit and equity
If the economy experiences an unexpectedly high rate of inflation, the group that would tend to benefit is___________.
debtors (people or businesses who owe money)
Economic agents who borrow funds are known as (creditors/debtors/spenders), the funds that they borrow are referred to as (capital/credit/debt), and this activity occurs in the (credit or financial/credit or loanable funds/loanable funds or debit) market.
debtors; credit; credit of loanable funds
Banks and other financial institutions of an economy are in the business of channeling funds from suppliers of financial capital to users of financial capital. This process is known as ____________.
financial intermediation
when the equilibrium is restored in the credit market, the flow of credit will be (higher/lower)
higher
Banks raise the nominal interest rate by 2 percentage points after inflation rises by 4 percentage points.
if banks raise the nominal interest rate by 2 percentage points after inflation rises by 4 percentage points, then the real interest rate falls by 2 percentage points. since the credit demand depends inversely on the real interest rate, it would rise with a fall in the interest rate and the economy is likely to move along the curve to point C
When large firms and the general banking community lose confidence in a weak bank, FDIC insurance is (an adequate remedy for/incapable of alleviating/legally barred from treating) the situation.
incapable of alleviating
According to the graph, this action by households causes the equilibrium real interest rate to (be indeterminate/increase/decrease) and the equilibrium quantity to (be indeterminate/increase/decrease)
increase; increase
When the value of a bank's assets is less than its liabilities, the bank is said to be____________.
insolvent
Which of the following equations correctly describes the Fisher equation?
nominal interest rate = real interest + inflation (the fisher equation describes the relationship between nominal (i) and real (r) interest rates when there is inflation (pi))
Banks usually hold a small pool of reserves because ____________.
on most days the withdrawals of existing deposits are roughly offset by inflows of new deposits
The credit demand curve is the schedule that reports the relationship between the quantity of credit demanded and the (nominal/real) interest rate.
real (the credit demand curve is the schedule that reports the relationship between the quantity of credit demanded and the real interest rate. this is because it is the real interest rate, r, that matters for business and individual decisions; therefore, the demand for credit is a function of this real interest rate)
Now suppose that government budget deficits rise dramatically. With this situation, at the previously determined equilibrium real interest rate, we will find a credit (surplus/shortage), causing the real rate to (increase/decrease).
shortage; increase
The 1970s saw a period of high inflation in many industrialized countries including the United States. Due to the increase in the rate of inflation, lenders, including credit card companies, revised their nominal interest rates upward. How is the rate of inflation related to the nominal interest rate that credit card companies charge, and why would lenders need to increase the nominal interest rate when the inflation rate increases?
the nominal rate of interest is the real rate of interest plus the rate of inflation; lenders need to raise the nominal rate when inflation increases to maintain their desired real return
Excluding cases where banks had accumulated a lot of non-deposit liabilities that are not covered by FDIC insurance, would analysts generally agree that deposit insurance has been successful in preventing bank runs?
yes, since bank runs and bank failures have been relatively rare since the advent of deposit insurance
Toby takes a one year loan from the bank for $40,000. The bank charges a nominal interest rate of 7.25% per annum. The total amount Toby will have to pay to the bank after a year will be $
(note that the total amount to be repaid is equal to the interest amount along with the principal amount) 40,000(1+.0725) = 42,900
The solar energy industry in country Z is relatively new, has significant barriers to entry, and there are only a handful of small-scale producers currently in the market. On the otherhand, the coal energy industry (which offers a substitute for solar energy) has been long-established and has many large-scale producers currently in the market. In light of the recent Paris agreement and the government of country Z's ratification, the government announces incentives for the consumption and production of solar energy. In the adjacent diagram (Graph 2), CD1 depicts the aggregate credit demand curve of country Z before the government's announcement. Using the line drawing tool, show the shift in the curve due to the government announcement for a fixed level of the real interest rate and label the curve appropriately.
(note the information presented in the question and consider the factors which lead to a shift in the credit demand curve; and, try again) Changes in perceived business opportunities for firms can cause the demand curve to shift. With the announcement of government incentives for the consumption and production of solar energy, the producers in this industry would want to increase their production and would have to borrow money to do so. This increase in credit demand would shift the credit demand curve to the right. But, since the government now favors solar energy to coal energy, coal energy producers would perceive a fall in their business opportunities as they provide a good which is a substitute for solar energy. The coal energy producers would want to decrease their production and hence their credit demand would fall. This will shift the credit demand curve to the left. And, as it is given that the coal energy industry is larger in comparison to the solar energy industry, with many large-scale producers in the market, this leftward shift would be greater than the rightward shift due to the solar energy producers. Hence, the overall shift in the curve would be towards the left.
Usury laws place an upper limit on the nominal rate of interest that lenders can charge on their loans. In the1970s, some credit card companies moved to states where there were no ceilings on interest rates to avoid usury laws. Why would credit card companies move to states without usury laws during a period of high inflation, like the1970s?
(real rates are not necessarily negative, only less than the lending institutions may find acceptable) - because usury laws ceilings may limit the real return lenders can earn during inflationary periods, lenders have an incentive to move to states without such laws
In 1981, the annual inflation rate in the U.S. was about 10 percent, and the U.S. short-term nominal interest rate was about 12 percent. Over the next 38 years, both the inflation rate and short-term nominal interest rate tended to fall. By 2019, the inflation rate was about 2 percent and the short-term nominal interest rate was also about 2 percent. How did the real short-term interest rate change from 1981 to 2019?
(recall that the real rate of interest (r) is defined as the nominal rate (i) less the inflation rate (pi) the real rate remained stable at -2 percent
According to the graph, this perception causes the equilibrium real interest rate to (be indeterminate/increase/decrease) and the equilibrium quantity to (be indeterminate/increase/decrease)
(this perception on the part of the economy's businesses causes the equilibrium real interest rate to increase and the equilibrium quantity to be indeterminate)
according to the graph, this perception causes the equilibrium real interest rate to ________ and the equilibrium quantity to ______
(this perception on the part of the economy's households causes the equilibrium real interest rate to decrease and the equilibrium quantity to be indeterminate) decrease; be indeterminate
what are some factors that explain why people save for the future
*people save for many reasons, including for their children, for retirement, for predictable large expenses, for a "rainy day," and to invest in a personal business - people save to invest in a person business - people save fro retirement - people save for their children
A shift in the credit supply curve can be caused by ____________.
- an elevated perception o the part of households that the future may hold many "rainy days" - an aging population that is ill-prepared for retirement - a heightened desire on the part of firms to internally fund their future activities
a shift in the credit demand curve can be cause by ___________.
- changes in government policy - changing in household preferences or expectations - changing in perceived business opportunities for firms
What is the shadow banking system?
- financial institutions that make loans from funds raised by means other than by accepting deposits - nonbank financial institutions that behave like banks in many respects - a group of several thousand disparate nonbank financial intermediaries
Households and firms with savings lend money to banks and other financial institutions. The credit supply curve shows the relationship between the quantity of credit supplied and the real interest rate. The credit supply curve slopes upward because a ____________.
- higher interest rate encourages more saving - higher real interest rate discourages current consumption
which of the following are functions banks perform as financial intermediaries in the economy?
- identify profitable lending opportunities - transform short-term liabilities into long-term assets - manage risk through diversification strategies
When the value of a U.S. bank's assets become less than its liabilities, the government, through the FDIC, ___________.
- shuts the bank down and makes payouts to its depositors - searches for a healthy bank to take over its operations
If a bank runs short of reserves, a reasonable step would be to ____________.
- stop making new loans - sell some of its illiquid long-term assets
what is the difference between nominal and real interest rates?
- the real interest rate is the nominal rate adjusted for inflation - the nominal interest rate is the rate you pay on a loan
why do the inflation rate and the nominal interest rate tend to move together over the long-run
- this synchronized movement indicates that credit market conditions have tended to be relatively stable over time - their up and down together movement tells us that the real interest rate is relatively stable in the long run
Optimizing economic agents use the real interest rate when thinking about the economic costs and returns of a loan. Suppose the rate paid by banks on savings accounts is 0.9 percent at a time when inflation is around 1.25 percent. For the saver, the real rate of interest on his or her savings is ______ percent.
1.25-0.9 = -.35
The figure on the right shows the credit market in equilibrium with the real interest rate at ______ percent and the flow of credit equal to _______ billion.
2.5%; 25 billion
If banks expect that the rate of inflation in the long run will be 4.25 percent and they want a real return of 8.5 percent on a certain category of loans, then the nominal rate they should charge borrowers on those loans is _________ percent.
4.25+8.5 = 12.75
The depositors of JS bank were worried that the value of this bank's assets was less than the value of its liabilities, so they started to withdraw their deposits from the bank. This expanding panic and rising flood of withdrawals is called
A bank run occurs when a bank experiences an extraordinarily large volume of withdrawals driven by a concern that the bank will run out of liquid assets with which to pay withdrawals. When the depositors in JS bank worry that the value of a bank's assets is less than the value of its liabilities they are actually worried about their deposits with the bank. They fear that the bank will run out of liquid assets with which it pays its withdrawals. This expanding panic will lead to an extraordinarily large volume of withdrawals. - a bank run
The government increases its spending on infrastructure by financing it through borrowing.
Holding all else equal, an increase in government borrowing shifts the market credit demand curve to the right. therefore, if government borrowing increases to finance the increased spending on infrastructure, the economy is likely to move to point D
Which of the following options would result in an efficient allocation of this amount in the economy?
If Tina puts this money at home or in a safe deposit locker, she would not earn any interest on this amount. In the presence of inflation in the economy, she would earn a negative real interest rate instead and lose some purchasing power. Additionally, if this money was invested in the credit market, it would've helped a borrower who needs this money. If Tina lends money to Brad, a gambler, this would be highly risky. Credit markets play an extremely valuable social role. By enabling savers to lend their excess money to borrowers, the credit market improves the allocation of resources in the economy. Unknown to Tina, there could be several borrowers(possibly more reliable than Brad) who need that $5,000 for their investments. Without credit markets, they would also suffer because many of them would not be able to raise the necessary funds. - Tina deposits this amount in a bank so that it could then be lent to possibly more reliable borrowers than Brad.
Which of the following strategies can a bank adopt to prevent a bank run without facing any repercussions?
The banks are very eager to avoid a bank run. As always, prevention is the ideal cure. The ultimate source of strength is to have lots of stockholders' equity, implying that a bank has assets that far exceed the value of its liabilities. When a bank owns far more than it owes, it is said to be well capitalized. In this case, the public should have no doubt about a bank's solvency, which reduces the likelihood of a bank run. If a bank is running short of reserves, it can stop making new loans, liquidate illiquid assets prematurely, and sell its long-term investments. However, these efforts can backfire because they may actually reveal that a bank is in trouble and can intensify the panic that may already have begun. Therefore, such a move can further confirm the public's doubt about a bank's solvency which increases the likelihood of a bank run. - it starts holding lots of stockholders' equity
An institutional bank run takes place when economic agents such as (households and firms/households and banks/firms and banks/households) withdraw their deposits and their short-term loans from a weak bank. Such bank runs (cannot/can) be prevented by the relevant (government) insurance agency.
The households aren't the only economic agents depositing money at banks. Firms also hold bank accounts. Moreover, banks borrow money from one another. When large firms and the general banking community lose confidence in a weak bank, an institutional bank run may ensue in which firms and banks withdraw their deposits and their short-term loans from the weak bank. The relevant (government) insurance agency won't prevent institutional bank runs because institutions make deposits and short-term loans that vastly exceed the insurance cap per account. - firms and banks - cannot
a bank run is
an extraordinarily large volume of withdrawals driven by a concern that a bank will run out of liquid assets with which to pay withdrawals
When a bank experiences withdrawals of deposits and short-term loans by firms and otherbanks, the situation is described as ____________.
an institutional bank run
