ECON 120 ch 9: Savings, Interest Rates, and the Market for Loanable Funds

Sort the listed factors into those that affect the supply curve for loanable funds and those that affect the demand curve.

Affect the Supply Curve: consumption smoothing time preferences wealth income age distribution of the population Affect the Demand Curve: productivity of capital investor confidence

Sort the listed factors into those that affect the supply curve for loanable funds and those that affect the demand curve.

Affect the Supply Curve: income consumption smoothing time preferences age distribution of the population wealth Affect the Demand Curve: investor confidence productivity of capital

The amount of investment in an economy exceeds the amount of savings during a recession.

False

As baby boomers retire, they will start drawing down the savings in their retirement accounts. Unless another source of loanable funds comes into play, there will be a shift in the equilibrium of the loanable funds market. Click on the graph that illustrates what will happen.

S1 back to S2; interest rate rises; savings and investment decreased

The main determinants of the demand for loanable funds are - and investor confidence. The latter is a measure of firms' views about - economic activity. Investors often alter their expectations for good reasons, but Keynes also considered - waves of pessimism and optimism, which he spoke of as resulting from "animal spirits," as determinants of confidence.

capital productivity; future; irrational

U.S. personal savings fell significantly during the 1980s and 1990s. Why didn't the supply of loanable funds experience a similarly significant contraction?

increased foreign wealth and income

When the loanable funds market is in equilibrium, savings equals -. Above the equilibrium interest rate, the quantity of loanable funds demanded would be lower than the amount people are willing to -, putting - pressure on the interest rate.

investment; save; downward

Loni owns a software company and has a great idea for a new app. In order to build the app, she will need to hire a computer expert for one year at a salary of $87,000. (Assume this is the only expense required to create this app.) However, she expects to make $99,000 by selling the app. Since Loni does not have any extra cash on hand, she goes to the bank, where they offer to lend her $87,000 with an annual interest rate of 15%. Should Loni take the loan and build the app?

no

Consider the typical individual engaged in consumption smoothing. Match the following phases of that person's life to the financial activity he or she would most likely engage in during that phase.

saving: prime earning years dissaving: later life borrowing: early life

Apply the correct label to each description.

the interest rate that newspapers report and that financial transactions are recorded in: nominal interest rate a measure of the true purchasing power of savers' return from savings: real interest rate a price of loanable funds, quoted as an annual: interest rate

Jane would like to borrow $850 for exactly one year, so that she can buy a brand-new lawn mower for the lawn-mowing business she is starting. Jane's local bank agrees to lend her the money only if she is willing to pay back the full amount plus an extra $30, for a total repayment amount of $880. What is the annual interest rate on Jane's loan from her bank? Give the answer as a percentage, rounded to one decimal place.

3.5%

Given the supply and demand curves shown, where would the interest rate end up if the quantity of loans supplied started out at $200 billion?

5%

Match each event to its effect on the equilibrium interest rate and the amount of investment in the loanable funds Apply the appropriate label to each event.

Firm owners expect reduced sales in the future.: lower interest rate, less investment A wave of retirees stops working and begins drawing on retirement savings: higher interest rate, less investment An efficient new source of energy effectively increases the return on owning a factory: higher interest rate, greater investment Immediate consumer gratification is no longer preferred by people: lower interest rate, greater investment

Helene, the owner of an organic produce stand, has a chance to buy a plot of land that—after material and labor expenses—would generate a profit of $1,300 per year. To buy the $20,000 plot, she would have to take out a loan on which she would make interest-only payments equal to 5% of the cost of the plot every year. What should Helene do to maximize her profit? Assume that when it is time to repay the loan principal, the land could be resold at the same price.

Helena should take the loan and buy the land.

Which of the following events results in an increase in the nominal interest rate?

Inflation increases while the real interest rate remains constant. Inflation drops by 2 percentage points, while the real interest rate increases by 3 points. Inflation increases from 2% to 5%, while the real interest rate increases from 0% to 3%.

The market for - is where savers supply funds for loans to borrowers. This market is critical to an economy's output, or GDP. Firms can only generate - after they have produced something, and unless they have a reserve of unused cash they cannot pay for -, like machines and workers, unless they can borrow first. Therefore, without this market, many firms could not get started.

loanable funds; revenue; investments

Suppose you know that the equilibrium amount of investment in the global market is $10.4 trillion, the equilibrium interest rate is 5.5%, the income tax rate is 7%, and government spending accounts for 30% of global GDP. What is the equilibrium amount of global savings, in trillions of dollars?

10.4

In 1982, the savings rate was above -. It fell for nearly three decades before reaching a low of - in 2005. Yet, as real estate and stock prices fell throughout 2008 and 2009, the savings rate climbed back above -.

11%; 2.5%; 6%

The graph depicts the U.S. nominal interest rate and real interest rate between 1965 and 2015. Keeping in mind the Fisher equation, click on the time period during which the inflation rate briefly turned negative.

2005 to 2010

Consider the personal savings rate in the United States. Order these years according to savings rate, beginning with the year in which the savings rate was lowest.

2005, 2011, 1981

Which of the following events results in a decrease in the real interest rate?

Correct Answer(s): Inflation rises, while interest paid by banks drops. Inflation increases, while the nominal interest remains the same.

Which of the following events would cause the supply of loanable funds to shift?

Correct Answer(s): a crash in real estate value and stock market prices a baby boom generation entering its prime earning years

Why is interest typically paid on a loan?

Correct Answer(s): to compensate the lender for the risk that the loan will not be repaid to compensate the lender for temporarily making do without the money that was lent

Assume that the demand for loanable funds is initially at D1 in the figure below, during a time of high unemployment. Which demand curve will most likely result from a new report that unemployment has dropped and is expected to continue declining? (Click on the correct curve.)

D2

Assuming that the demand for loanable funds is initially at D1 in the figure below, which demand curve will most likely result from an act of foreign aggression that leaves businesses pessimistic about future prospects for international trade? (Click on the correct curve.)

D3

During the Great Recession, a decrease in investor confidence was one reason that real investment fell from $2.2 trillion in 2007 to a low of $1.4 trillion in 2009. Click on the graph that illustrates these events.

Interest rates decreased; savings and investments decreased; demand <---

During two recent U.S. recessions, we can see that investment fell substantially. Naturally, a recession could generate pessimism about the future economy, causing investor confidence (and, therefore, the demand for loanable funds) to fall. But a fall in supply of loanable funds could also lower equilibrium investment. Which of the following provides the strongest evidence that a fall in the demand for, and not the supply of, loanable funds is an important reason for decreased investment during these two recessions?

Interests rates fell.

Assume that the United States initially has loanable funds supply curve S1. Now, imagine that developing Asian nations experience an increase in their wealth and income. Click on the curve that best represents the U.S. loanable funds supply after this increase.

S2

Using only the information in the table, place the four people listed in the most plausible order according to their personal savings rate, starting with the lowest.

Sam, Simon, Steve, Jamie

In the mid-twentieth century, there was a surge in births in the United States, yielding a generation that was more populous than those immediately before or after. As more of this cohort, known as the baby boomers, enters retirement and engages in dissaving rather than saving, the supply of loanable funds will tend to decrease. Assuming that the average retirement age is 65, by what year did or will the baby boomers start to draw on retirement?

2011

Apply the appropriate label to each event.

After U.S. quarterly GDP repeatedly exceeds expectations, businesses become more optimistic about future earnings: increased investor confidence A new 18-wheel truck is so fuel efficient that many truckers find it profitable to replace their trucks: increased productivity of capital City regulations reduce the profitability of new rental apartments: decreased productivity of capital A new government in Canada creates worry regarding the future of several free trade agreements: decreased investor confidence