ECON 2301-01 CH. 14

Inflationary premium

A component of the money interest rate that reflects compensation to the lander for the expected decrease, due to inflation, in the purchasing power of the principal & interest during the course of the loan. It's determined by the future inflation's expected rate.

Key Point 4: Inflationary Times

During Inflationary Times, The Money Rate of Interest incorporates an Inflationary Premium reflecting the expected future increase in the price level. When inflation is expected, the Money Rate of Interest exceeds the Real rate of interest.

Saving

Current Income that's not spent on consumption goods. Saving makes it possible for resources to be devoted to investments (like making tractors or other kinds of production-focused equipment)

Key Point 8: Capital Allocation

Economic profit plays a central role in allocating capital & determining which investment projects will be undertaken. In a competitive environment, Economic profit reflects uncertainty & entrepreneurship - the ability to recognized & undertake profitable projects that have gone unnoticed by others

Capital

Resources that enhance our ability to produce future outputs

Positive rate of Time Preference

The Consumer's Desire for goods now rather than the future.

Money Rate of Interest

The Interest Rate in monetary terms that borrowers pay for borrowed funds. During periods when borrowers & lenders expect inflation

Real rate of interest

The Money Rate of Interest minus the expected rate of inflation. The Real rate of interest indicates the interest premium in terms of real goods & services that one must pay for earlier availability.

Key Point 5: Money Rate of Interest

The Money Rate of Interest on certain loans reflects the 3 basic factors: 1). The pure Interest Rates, 2). an Inflationary Premium, & 3). a risk premium that's directly related to the probability of default by the borrower.

Investment

The Purchase, construction, or development of capital resources, including both human & nonhuman capitals. Investments raises the capital supplies.

Key Point 6: Discounting procedure

The interest rate allows individuals to put a current value on future revenues & costs. The Discounting procedure can be used to calculate the present value of an expected net income stream from potential investment projects. If the present value of the expected revenues exceeds the present value of the expected cost - & if things turn out as anticipated - The projects will be profitable.

Present Value (PV)

The current worth of future income after it's discounted to reflect the fact that revenues in the future are valued less highly than revenues now PV = Receipt 1 Year from Now / 1 + Interest Rate

Key Point 3: Loanable funds

The demand for Loanable funds reflects the productivity of capital resources & the Positive rate of Time Preference. The market interest rate will bring the quantity of funds demanded by borrowers into balance with the quantity supplied by lenders.

Key Point 2: Interest Rate

The interest rate is the price of earlier availability. It's the premium that borrowers must pay to lenders to acquire goods now than later.

Key Point 7: Values & Timing

The present value of expected future net earnings will determine the market value of existing assets. An increase in the expected future earnings of an asset will increase its market value. Asset Value = Annual Net Income from the Asset / Interest Rate

Discounting

The procedure used to calculate the present value of future income, which is inversely related to both the interest rate & the amount of time that passed before the funds are received. EX: If the Interest Rate is 10%, then the present value of $100 received 1 year from now would be only $90.91 ($100 divided by 1,10). The present value of $100 received in 2 years from now is: PV = 100 / (1 + Interest Rate) ^ 2 = 89

Key Point 9: Capital Market

To grow & prosper, Nations must have a mechanism that will attract savings & channel them into investments that creates wealth. The capital market preforms this function in a market economy.

Key Point 1: Capital

We can often produce more consumption goods by 1st using our resources to produce physical & human capital resources & then using said resources to make the desired consumption goods. Because resources used to make capital goods will be unavailable for the direct production of consumption goods, saving is necessary for investment.