ECON Chapter 22 savings, interest rates, and the market for loanable funds

Why is interest typically paid on a loan?

Correct 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

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

Correct: Inflation increases, while the nominal interest remains the same. Inflation rises, while interest paid by banks drops. Incorrect: The nominal interest rate and the inflation rate drop by the same number of percentage points. Interest paid by banks goes up, while inflation remains the same.

Fill in the blanks to complete the passage about the demand for loanable funds.

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

Fill in the blanks to complete the passage concerning the market for loanable funds.

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

Ceteris paribus, which of these events would cause both the equilibrium interest rate and the equilibrium quantity of investment to fall?

correct: a decrease in investor confidence a decrease in capital productivity

What factors shift the supply of loanable funds?

income and wealth; time preferences; consumption smoothing

time preferences

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

nominal interest rate

the interest rate before it is corrected for inflation

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 The interest rate, tax rate, and government share of GDP are irrelevant. In equilibrium, savings equals investment.

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% This is the interest rate at equilibrium, where quantity supplied equals quantity demanded.

The drop in U.S. savings during the 1980s and 1990s was likely the result of decreased income and wealth.

False reason: Income and wealth increased during this period. Economists do not have a consistent explanation for this drop, but one possibility is strengthened time preferences during this period. Another possibility is that savings were reduced in favor of investment in stocks and other assets.

Fill in the blanks to complete the passage concerning consumption smoothing.

In order to have a lifetime pattern of consumption that is (less) varied (that is, smoother) than the pattern of income, people tend to (borrow) early in life, (repay loans) and save during prime earning years, and (dissave) late in life.

Assume that initially a country has a loanable funds supply curve of S1. Now, imagine that interest rates across the country increase by 3%. Click on the curve that best represents the loanable funds supply after this increase.

S1 When interest rates change, the quantity supplied slides along the supply curve for loanable funds. The supply curve doesn't shift.

Fisher equation

equation stating that the real interest rate equals the nominal interest rate minus the inflation rate real interest rate = nominal interest rate − inflation rate

real interest rate

the interest rate that is corrected for inflation

loanable funds market

the market where savers supply funds for loans to borrowers

Match each term to the phrase that best describes it.

withdrawing funds from one's previously accumulated savings (dissaving) a preference for consuming now rather than saving for later (strong time preference) evidence that households want their consumption to be more consistent than their income (consumption smoothing) a willingness to save now and consume later (weak time preference)

dissaving

withdrawing funds from previously accumulated savings

two factors that cause shifts in the demand for loanable funds

the productivity of capital and investor confidence

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

false During a recession, the amount of real investment and savings may both fall together, but they still remain equal.

savings rate

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

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. Name Age Annual income Time preferences Steve 33 years $20,000 Weak Jamie 33 years $80,000 Weak Sam 20 years $18,000 Strong Simon 33 years $20,000 Strong

sam simon steve jamie

Fill in the blanks to complete the passage about the role of lending and borrowing in an economy.

The market for (loanable funds) is where savers supply funds for loans to borrowers. This market is critical to an economy's output, or GDP. Firms can only generate (revenue) after they have produced something, and unless they have a reserve of unused cash they cannot pay for (investments), like machines and workers, unless they can borrow first. Therefore, without this market, many firms could not get started. The loanable funds market is a key element in a healthy economy. Without a well-functioning loanable funds market, future GDP dries up.

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

a crash in real estate value and stock market prices a baby boom generation entering its prime earning years

investor confidence

a measure of what firms expect for future economic activity

interest rate

a price of loanable funds, quoted as a percentage of the original loan amount; the price a borrower pays to a lender to use the lender's money

consumption smoothing

behavior occurring when people borrow and save to smooth consumption

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 reason: While U.S. domestic savings decreased, the U.S. loanable funds market was seen as a relatively safe place for developing nations to save their growing wealth.

which of the following is a true statement? -when making decisions about saving and borrowing, people care about the nominal interest rate -Profit-maximizing firms will borrow to fund an investment if and only if the expected return on the investment is equal to the interest rate on the loan -a falling interest rate will lead to a movement along the demand curve for loanable funds- -If the rates of return on fine art purchases fall, savers will be more inclined to put their savings into art as an investment

a falling interest rate will lead to a movement along the demand curve for loanable funds