Real Interest Rate determination (Exam 3)
Gov borrowing effect on private spending
"crowds out" private spending (mostly)
total factor productivity
physical and human capital changes
interest rate
price paid to a lender for borrowing funds over time
Kyle deposits $5000 into a savings account that pays an annual interest rate of 5%, compounded monthly. The amount in the account after 10 years is:
$8235.05 (see picture)
Ex. Henley lends $100 to Maddy at a 6% annual interest rate, with principal and interest due in 1 year
100*(1+0.06) = $106
Ex. Henley lends $100 to Maddy at 6% interest rate, with principal and interest due in TWO years
100*(1.06)*(1.06) = $112.36 Extra $0.36 is the interest that accumulated on interest
Compound Interest Formula
A=P(1+r/n)^nt
D/S equilibrium and surplus
At EQ, both sides benefit (both gain)
interest rate expressed as
a PERCENT of the principle
real interest rate
adjusted for inflation - takes into account PPM
How to make compound interest formula accurate
all terms have to be expressed in the same TIME (years, quarters, months)
principal
amount borrowed
demand for loanable funds
borrowers MAX willingness to pay - downward sloping line (higher interest rate = less willing)
Government borrowing
borrows to finance its expenditures demand increases (shifts up/right) - interest rate rises - private savers save MORE - private borrowers borrow LESS
Savers become less patient
decrease supply curve (up/left) quantity of loanable funds decreases higher new real interest rate, r*
total factor productivity increases
increases demand (up/right shift) higher new real interest rate, r*
population ages (2 parts)
initially: increases SUPPLY (shift down/right) then: decreases SUPPLY (shift up/left)
compounding interest
interest paid on interest
do higher interest rates reduce borrowing
never reason from a price change sometimes when rates rise, L* decreases sometimes higher rates are met with higher L* (increase in productivity)
interest rates are typically reported as ____ rates? (ex. mortgage)
nominal
real interest rate formula
real interest rate = nominal interest rate - inflation rate (π)
nominal interest rate
regardless of inflation (purchasing power of money)
Supply of loanable funds
saver's MIN willingness to accept - upward sloping - opportunity cost