ECON_4130: Chapter 4
The government proposes a new tax on saving, based on the value of people's investments as of December 31 each year.
The supply of loanable funds would decrease, increasing the interest rate.
In the loanable funds model, why is the demand curve downward sloping? Why is the supply curve upward sloping?
The demand curve is downward sloping because the higher the interest rate, the less the demand for borrowing. The supply curve is upward sloping because the higher the interest rate, the more willing suppliers of loanable funds will be to lend money.
Investors believe that the level of risk in the stock market has declined.
The demand curve shifts to the left.
What are the determinants of asset demand?
The expected rate of return and the degree of risk for an investment compared to alternative investments. The liquidity of the investment compared with other investments. The total amount of savings to be allocated among investments.
The graph indicates that the net effect is that the quantity of Treasury bonds transacted ( ) while the price ( )
increases may increase or decrease depending on the relative size of the shifts
As a result, the new equilibrium interest rate on bonds ( ), and the equilibrium quantity of bonds will ( )
is indeterminate increase
Many things can affect demand and supply in the oil market; one example is the increasing popularity of electric cars. Why would the analyst distinguish the spread of the coronavirus as a "black swan situation" rather than just one of many factors affecting the demand for oil?
Because competition and innovation are known and expected factors while the coronavirus was an unlikely and unexpected situation.
Compare the bond market approach to the loanable funds approach by explaining the following for each approach. What the good is In the bond market, the good is the ( ) and in the loanable funds market, the good is the ( ) Who the buyer is In the bond market, the buyer is the ( ) and in the loanable funds market, the buyer is the ( ) Who the seller is In the bond market, the seller is the ( ) and in the loanable funds market, the seller is the ( ) What the price is In the bond market, the price is ( ) and in the loanable funds market, the price is ( )
Bond use of funds lender borrower borrower lender the bond price the interest rate
The federal government imposes a tax of $10 per bond on bond sales and bond purchases.
Both the demand and supply curves shift to the left.
How does diversification reduce the risk of a financial portfolio?
By allocating savings among many different assets, if one asset class performs poorly, the rest of the portfolio may perform well.
Widespread use of handheld computers helps reduce business costs.
Expected profitability would rise, so the demand for loanable funds would rise.
Changes in which of the following variables would result in the supply curve for bonds shifting to the right? (Check all that apply.)
Government borrowing increases. The expected profitability of firms increases. Subsidies to business increase.
In early 2020, an article on bloomberg.com discussed the effects of the Covid-19 pandemic on the world oil market. Covid-19 first appeared in the Chinese city of Wuhan in late 2019 and led to significant disruptions to the Chinese economy. The article quoted one financial analyst as saying that the oil industry was "contending with a potential black swan situation." What did the analyst mean by a "black swan situation"?
It is a situation that only occurs rarely but that has a large impact on the economy.
( ) is the risk that is common to all assets of a certain type, while ( ) is the risk that pertains to a particular asset rather than to the market as a whole.
Market risk idiosyncratic risk
How would the following events affect the demand for loanable funds in the United States? Many U.S. cities increase business taxes to help close their budget deficits.
Net expected profitability would fall, so the demand for loanable funds would fall.
For each of the following situations, explain whether the demand curve for bonds, the supply curve for bonds, or both would shift. Be sure to indicate whether the curve(s) would shift to the right or to the left. The Federal Reserve publishes a forecast indicating that the inflation rate will average 4% over the next 5 years. Previously, the Fed had been forecasting an inflation rate of 2%.
The demand curve shifts to the left and the supply curve shifts to the right.
Briefly explain what typically happens to interest rates during a recession. Use a demand and supply graph for bonds to illustrate your answer.
The demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate. https://imgur.com/uDOeb9B
Taxes on businesses are expected to be increased in the future.
The demand for loanable funds would decrease, decreasing the interest rate.
In a large open economy, how would each of the following events affect the equilibrium interest rate? A natural disaster causes extensive damage to homes, bridges, and highways, leading to increased investment spending to repair the damaged infrastructure.
The demand for loanable funds would increase, increasing the interest rate.
Changes in which of the following variables would result in the demand curve for bonds shifting to the left? (Check all that apply.)
The expected return on stocks increases. Expected inflation increases. Household wealth decreases.
In what sense do investors face a trade-off between risk and return?
The higher the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a high demand, which lowers their yield or return.
The government eliminates the tax deduction for interest homeowners pay on mortgage loans.
The increase in the expected after-tax real interest rate would reduce the demand for loanable funds.
The federal government runs a series of budget surpluses.
The supply curve shifts to the left.
The economy experiences a period of rapid growth and rising corporate profits.
The supply curve shifts to the right.
The World Cup soccer matches are being televised, and many people stay home to watch them, reducing consumption spending.
The supply of loanable funds would increase, decreasing the interest rate.
The supply curve for bonds shifted as a result of ( ) The demand curve for bonds shifted as a result of ( )
an increase in expected profitability for businesses an increase in household wealth
As a result, the equilibrium interest rate will be ( )
higher
In February 2020, President Trump sent to Congress a budget proposal for federal spending and taxes. The budget proposal assumed that the growth of the U.S. economy would be faster than many economists were forecasting. (In fact, the economy was about to enter a recession caused by the Covid-19 pandemic.) If the Trump administration's forecasts of faster-than-expected economic growth had turned out to be correct, illustrate the effect on the market for corporate bonds in the United States. 1.) Using the line drawing tool, depict the impact on the supply of corporate bonds if the forecast of faster-than-expected economic growth turned out to be correct. Label this line as 'S2'. 2.) Using the line drawing tool, depict the impact on the demand for corporate bonds if the forecast of faster-than-expected economic growth turned out to be correct. Label this line as 'D2'. 3.) Using the point drawing tool, identify the new equilibrium in the bond market. Label this point as 'E2'.
https://imgur.com/EFvEJjt Demand and supply shift to left
Many economists assume that a boom in the stock market is a sign that profitable business opportunities are expected in the future. In other words, the expected return on stocks increases. Part 2 1.) Using the line drawing tool, show the impact of a stock market boom on the equilibrium interest rate. Properly label your line. 2.) Using the point drawing tool, indicate the new equilibrium price and quantity of bonds. Label your point 'E'.
https://imgur.com/a2JE8Bt Demand curve shift to left
Use a demand and supply graph for bonds to illustrate the following situation. The government runs a large deficit and households believe that future tax payments will be higher than current tax payments, so they increase their saving. Using the line drawing tool, draw the either a new bond supply curve or a new bond demand curve or both. Properly label any lines you draw.
https://imgur.com/itjS4CC Basically, demand curve and supply curve shift to the right.
Between 2012 and 2020, the annual inflation rate in the United States was less than 3% every year. Some economists and policymakers were afraid that during a future recession, the United States might experience deflation, or a decline in the price level. Suppose that after a recession begins, the federal government's budget deficit increases at the same time that the U.S. economy experiences deflation. Use a graph of the market for U.S. Treasury bonds to show the effect of these developments on the equilibrium price of Treasury bonds. Part 2 1.) Using the line drawing tool, depict the impact on the supply of U.S. Treasury bonds. Label this line as 'S2'. 2.) Using the line drawing tool, depict the impact on the demand for U.S. Treasury bonds. Label this line as 'D2'. 3.) Using the point drawing tool, identify the new equilibrium in the bond market. Label this point as 'E2'.
https://imgur.com/wRhefUx supply and demand shift to right