Macro Economics - Chapter 9

If you save $1,000 for one year with an interest rate of 6%, this brings you $1,060 next year, which is computed as:

$1,000 + (6% of $1,000) = $1,000 + $60 = $1,060

Suppose that U.S. citizens suddenly become wealthier. As a result, the _________ for loanable funds _________ and borrowers issue _____________ stocks and bonds to finance capital improvements.

Suppose that U.S. citizens suddenly become wealthier. As a result, the supply for loanable funds increases and borrowers issue more stocks and bonds to finance capital improvements.

How do we apply the loanable funds market model?

We can use the loanable funds market model to examine real-world changes in both supply and demand for loanable funds. The loanable funds model also clarifies the important implication that every dollar borrowed requires a dollar saved.

Holding other factors constant, when baby boomers retire and they begin to switch from savings to consumption, which of the following is likely to increase?

interest rates

Investor confidence

is a measure of what firms expect for future economic activity. If confidence is high, they are more likely to borrow for investment at any interest rate.

In contrast, the nominal interest rate

is the interest rate before it is corrected for inflation; it is the stated interest rate. In our example, the interest rate of 6% is the nominal interest rate.

The real interest rate

is the interest rate that is corrected for inflation; it is the rate of return in terms of real purchasing power.

loanable funds market

is the market where savers supply funds for loans to borrowers

In the market for loanable funds, __________ flow from banks to borrowers.

laons

We can rewrite the Fisher equation to see how inflation generally increases nominal interest rates:

nominal interest rate = real interest rate + inflation rate (Equation 9.2)

Factors That Shift the Supply of Loanable

*Income and wealth • Increases in income and wealth increase the supply of loanable funds. Savings is more affordable when people have greater income and wealth. • Decreases in income and wealth decrease the supply of loanable funds. *Time preferences • Increases in time preferences decrease the supply of loanable funds. Lower time preferences indicate that people are more patient and more likely to save for the future. • Decreases in time preferences increase the supply of loanable funds. *Consumption smoothing • If more people are in midlife and their prime earning years, savings is higher. Income varies over the life cycle, but people generally like to smooth their consumption. • If fewer people are in midlife, savings is lower.

Which of the following are considered examples of direct finance?

Apple stocks and Microsoft bond

What factors shift the demand for loanable funds?

Capital productivity is the main determinant of the demand for loanable funds. Investor confidence also affects the demand for loanable funds.

What factors shift the supply of loanable funds?

Changes in income and wealth shift the supply of loanable funds. Changes in time preferences also affect the supply of loanable funds. Consumption smoothing is another factor that shifts the loanable funds supply.

dissaving.

During this period of the life cycle, the income line exceeds the consumption line. Later in life, when people retire and their income falls, they tend to live on their savings. Dissaving occurs when people withdraw funds from their previously accumulated savings. Figure 9.6 shows dissavings as the shaded vertical area between income and consumption in later life.

Equilibrium also helps to clarify an important principle we'll return to often in this text. Investment requires saving because:

Every dollar borrowed requires a dollar saved.

In each of the following scenarios, identify whether the supply or demand curve shifts in the loanable funds market, and in what direction.

Part 1(2 points) There is a widespread fear that the Social Security retirement system will collapse. As a result, people begin to assume that they will need to pay their own way in retirement. The supply of loanable funds shifts to the right Part 2(2 points) A major discovery of oil in North Dakota leads to the creation of a tremendous number of high-paying jobs. The supply of loanable funds shifts to the right Part 3(2 points) A change in Americans' habits makes people less patient and more susceptible to instant gratification, causing their time preferences to become stronger. the supply of loanable funds shifts to the left .

This equilibrium condition reinforces a key relationship between savings and investment. Equilibrium occurs when:

Savings = Investment

normal consumption pattern, consumption smoothing

The blue line in Figure 9.6 represents a normal consumption pattern, which is smoother than the income pattern. This consumption smoothing is accomplished with the help of the loanable funds market.

hat is the loanable funds market?

The loanable funds market connects savers with borrowers. Savers are suppliers of loanable funds, and they earn interest as a reward for saving. Borrowers are the buyers of loanable funds, and they pay interest as the cost of borrowing.

Figure 9.1 illustrates the role of the loanable funds market. Savings flow in and become loans for borrowers. We could call it the market for savings, or even the market for loans. The term loanable funds captures the information in both.

The market for loanable funds is where savers bring funds and make them available to borrowers. Households (private individuals and families) are the primary suppliers of loanable funds. Firms are the primary demanders, or borrowers, of loanable funds. When this market is functioning well, firms get the funds necessary for production and savers are paid for lending.

Figure 9.2 shows the production timeline that we introduced in Chapter 8. At the end of the timeline is output, or GDP.

The production timeline illustrates that GDP depends critically on the loanable funds market. At the end of the production timeline we see output, or GDP. But before a firm can produce output, it must purchase resources. Since these purchases occur before the revenue comes in, firms must borrow at the beginning of the timeline.

What's happened to the savings rate in the U.S. since 1980?

The savings rate is lower now than in 1980.

An economist would describe a person who is 45 years old and saving a large amount of her income for retirement as someone who is engaging in

consumption smoothing.

Many interest rates in the United States recently fell. Which of the following factors could have been the cause?

decrease in the demand for loanable funds increase in the supply of loanable funds

____________ are on the demand side and _____________ are on the supply side of loanable funds market.

firms and governments; households

Automobile manufacturers are planning to adopt a new technology that will increase their overall productivity by 30%. As a result, equilibrium investment will ________________ and the equilibrium interest rate will _________________ in the loanable funds market.

increase; increase

The savings rate is

personal saving as a portion of disposable (after-tax) income.

An interest rate is a

price of loanable funds. It is like the price of toothpaste or computers or hoodies; it is simply quoted differently—as a percentage of the original loan amount.

Which of these factors affects the demand for loanable funds?

productivity of capital

In general, we can approximate the real interest rate by subtracting the inflation rate from the nominal interest rate in an equation known as the Fisher equation:

real interest rate = nominal interest rate - inflation rate (Equation 9.1)

The term time preferences

refers to the fact that people prefer to receive goods and services sooner rather than later.

In exchange for savings, borrowers issue

stocks and bonds.

You work as a consultant to firms deciding whether to borrow funds to invest in new projects. For each of your clients listed in the table, you have determined the interest rate they can borrow at, and also the expected rate of return on their investment. Those rates are listed below.

the café the soccer team the candy company

uppose that capital becomes more productive. What would we expect to happen?

the equilibrium interest rate and amount invested would both increase.

nominal interest rate

the interest rate before it is corrected for inflation

lonable funds market

the market hwere savers supply funds for loans to borrowers