Macro Test 2 Part 2

time preferences

People generally prefer goods sooner than later, and funds are no different Would you rather have $50 now or $50 later? Weak time prefernces- more patient, shift supply to right making savings more available

fisher equation

Relates inflation to the real and nominal interest rates

Interest Rates and the Supply of Loanable Funds

When you save money, you are supplying funds. The price you receive in return is the interest Percentage (rather than dollars) Example: Interest rate = 3% per year $500 ×0.03 = $15 Saving $500 will pay $15 for the year

public savings

equals the amount of tax revenue the government retains after paying for government purchases and making transfer payments to households

Movement along demand curve for loanable funds

increase or decrease in quantity demanded) Caused by a change in the interest rate, which is the price of borrowing

Movement along the supply curve for loanable funds

increase or decrease in quantity supplied) Caused by a change in the interest rate, which is the price of borrowing

Loans are paid back at a __________ date

later date To compensate, you must pay someone to borrow from them, or they must pay you when you loan them your funds The longer the loan period, the higher the payment

savings vs income

savings come from the households, how much income they have + what they get from the government income- what they spend

national income accounting

the methods the Bureau of Economic Analysis uses to keep track of GDP, or total production and total income in the economy

the total value of saving in the economy must equal

the total value of investment

open economy

there is interaction with other economies in terms of both trading of goods and services and borrowing and lending

closed economy

there is no trading or borrowing and lending with other economies, so net exports are zero

When should a firm borrow?

Do a cost-benefit analysis Borrow funds if: Expected return on investment > Interest rate on loan This yields the inverse relationship between the interest rate and quantity demanded of loans that is embedded in the slope of the demand curve for loanable funds.

Future of the Loanable Funds Market in the United States

Drop in savings rate over past 30 years Increase in time preferences Leftward supply shift in loanable funds market Foreign savings in United States could shift supply back to the right Retirement of baby boomers Another reason to expect a leftward shift in the supply of funds Result could be less investment and reduced GDP growth

budget deficit

When the government spends more than it collects in taxes public saving is negative

balanced budget

When the government spends the same amount that it collects in taxes

private savings

equal to what households retain of their income after purchasing goods and services (C) and paying taxes (T).

Demand for Loanable Funds

Demanders of loanable funds are entities who want to borrow money Demand is driven largely by firms who need to borrow for large capital projects Governments also borrow Recall Borrowing must occur to build capital goods This occurs before any production of final goods

What is true about equilibrium in the market for loanable funds? A. Savings = Investment B. Interest rate = Inflation C. Investment = Interest Rate D. Savings = GDP

A. Savings = Investment

How will an increase in time preferences affect the loanable funds market? There will be... A. An increase in the supply of loanable funds B. A decrease in the supply of loanable funds C. An increase in the demand of loanable funds D. A decrease in the demand of loanable funds

B. A decrease in the supply of loanable funds

Which is an example of indirect finance? A. Ashley closes her account at Green Bank. B. Ethan deposits money in Blue Bank, and Jenna takes out a loan from Blue Bank. C. Lindsay buys a bond from a large pharmaceutical company. D. Derek buys 100 shares of stock at the initial public offering of a company.

B. Ethan deposits money in Blue Bank, and Jenna takes out a loan from Blue Bank.

Shift (increase or decrease) in the supply of loanable funds is caused by

Changes in income and wealth Change in time preferences Consumption smoothing (anything that would make saving more or less attractive)

Shift (increase or decrease) in the demand of loanable funds caused by

Changes in the productivity of capital Changes in investor confidence (anything that would make borrowing more or less attractive)

Supply of loanable funds

Comes from people saving money Interest rate is a reward for saving

Demand of loanable funds

Comes from people wanting to borrow money Interest rate is the cost of borrowing

What role do banks play in financial markets? A. Banks affect the money supply by minting new currencies B. Banks set the interest rate C. Banks sell stocks to the government D. Banks act as financial intermediaries between borrowers and savers

D. Banks act as financial intermediaries between borrowers and savers

Where does the supply of funds in the loanable funds market come from? A. Banks printing money B. Firms borrowing money for investment C. Government tax revenues from citizens D. Consumers saving their money at banks

D. Consumers saving their money at banks

In the basic consumption-smoothing model, when are consumers dissaving? A. During prime earning years B. In their 20s and 30s C. Very early in life D. Late in life

D. Late in life spending what they saved People are becoming less patient, want their consumption now and don't wanna save Left shift of supply

The interest rate can be thought of as... A. The rate at which banks loan funds B. The return on a capital investment C. The real rate of inflation D. The price of money

D. The price of money

investor confidence

If a firm is optimistic, it will borrow more today Changes in capital productivity and investor confidence will shift the demand for loanable funds Investor confidence not high, demand curve sifts left, interest rate decreases

Productivity of capital

If capital becomes more productive, the demand for loans will increase The returns on investment (at any interest rate) will be greater Example: Internet and computers

Equilibrium in the Market for Loanable Funds

In equilibrium, savings = investment Supply of loanable funds is people's savings Demand for loanable funds is firms wanting to borrow for investment purposes Relationship between saving and borrowing Every dollar borrowed requires a dollar saved

Consumption Smoothing

Income changes over the course of the typical lifetime Young students and elderly retirees don't work, but most people do earn income in between those years However, consumption does not change as much Young people and retirees still consume goods and services These goods and services are paid for by borrowing or using savings Consumption smoothing: we don' t experience large changes in consumption with changes in income.

Income and Wealth

Increases in income generally increase savings This can be graphed as a shift in the supply of loanable funds High-income people (and countries) save more than low-income people (and countries) at the same interest rate When people save, they also want to save where the interest rate is highest This is why many foreign investors have invested savings in the United States

Interest rate on the demand side

Interest rate is the cost of borrowing Interest rate bank pays you tends to be on lower side On the other hand, higher interest rates mean a firm pays more to borrow.

Good Price Sellers (suppliers) Buyers (demanders)

Loanable fund interest rate savers borrowers

nominal interest rate

The interest rate before it is corrected for inflation

real interest rate

The interest rate corrected for inflation

interest rate

The price of loanable funds Savers: the reward for saving Borrowers: the cost of borrowing Like other prices, it rises and falls Affected by supply and demand We can examine this market like any other market the price that gets paid to the bank by making funds available, pay it in order to get access to your money Many people, thinking about retirement, buying a house or car, or some other big purchase, worry about interest rate fluctuations and have no clear understanding as to why interest rates rise and fall. The interest rate is just the price of loanable funds, and if you know how to use supply and demand, you can determine what makes interest rates rise and fall.

Loanable funds "law of supply"

The quantity of savings rises when the interest rate increases If interest rate increases, quantity of savings increases If you have a positive balance in either a savings or checking account, you are a supplier in the loanable funds market. For savers, the interest rate is a reward. Every dollar saved today returns more in the future when the interest rate is positive. The higher the interest rate, the greater the returns in the future, and the more people want to save (increasing the quantity of loanable funds supplied).

income tax vs consumption tax

Under the income tax, households pay taxes on all income earned. Under a consumption tax, households pay taxes only on the income they spend. (So, households would pay taxes on saved income only if they spent the money at a later time.)

budget surplus

When the government spends less than it collects in taxes