ECON 2301: CH. 22 Study Guide

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.

In 1982, the savings rate rose above _____. It generally fell for nearly three decades before reaching a low of _____ in 2005. Yet as real estate and stock prices fell in the aftermath of the Great Recession of 2008-2009, the savings rate climbed as high as _____ in 2012, before falling to about the 6-8% range.

12%, 2.2%, 12% The decline in personal savings may be due to savers being less and less patient. But another possibility is that they have shifted their savings activity to assets not included in the official definition of personal savings—such as real estate (homes), and stocks and bonds.

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, 1975 The savings rate does not include personal investment in the stock market, though people may include stocks in their retirement portfolio.

In the mid-twentieth century (usually considered to be between 1946 and 1964), 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 1946 + 65 = 2011

Eve earns $68,000 per year as a lecturer. Each year, she spends $36,000. In addition, she gives $1,000 to charity and pays $16,000 in taxes. Of the money she has left, she saves $13,000 and invests $2,000 in the stock market. Calculate her personal savings rate. Round to the nearest whole percentage point.

25% The savings rate is the amount you save as a portion of disposable income. In this case, Eve's disposable income is what she earns, $68,000, minus the taxes she pays, $16,000 which equals $52,000. Since she saves $13,000, you determine the savings rate by taking $13,000 divided by $52,000 to arrive at a 25% savings rate. The personal savings rate is the percentage of disposable income that goes into savings (not counting investments).

If the nominal interest rate is 5.3% and the inflation rate is 2.1%, what would the real interest rate be?

3.2% The real interest rate is the nominal interest rate minus the inflation rate. You can find the real interest rate by subtracting the inflation rate from the nominal interest rate; this is one form of the Fisher equation.

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% This percentage represents the nominal interest rate on Jane's loan. The interest rate is calculated as:: interest rate = (amount repaid - original loan amount)/(original loan amount)

Suppose the interest rate that banks are charging their best customers is 5.5%, the inflation rate is 1.5%, and the most recent economic growth rate was 3.1%. Calculate the real interest rate that would result from this scenario (to the nearest tenth of a percent).

4.0% Real interest rate = nominal interest rate - inflation. The Federal Reserve always manages the rate of increase in the money supply so that the nominal interest rate does not change unless it takes action to change it.

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.

Real interest rate = nominal interest rate - inflation. The Federal Reserve always manages the rate of increase in the money supply so that the nominal interest rate does not change unless it takes action to change it.

5% This is the interest rate at equilibrium, where quantity supplied equals quantity demanded. Since demand at that rate would be for only $200 billion, the interest rate would fall until equilibrium was reached.

Suppose the real interest rate is 4.0%, the inflation rate is 1.5%, and the most recent economic growth rate was 3.1%. Calculate the nominal interest rate that would result from this scenario (to the nearest tenth of a percent).

5.5% Nominal interest rate = real interest rate + inflation. The Federal Reserve always manages the rate of increase in the money supply so that the nominal interest rate does not change unless it takes action to change it.

Jermaine lives in a world in which the nominal interest rate is 3% and the inflation rate is 1%. Fill in the blanks to complete the passage describing this scenario. Today, Jermaine has $100, with which he could purchase 500 kW/hr of electricity. However, Jermaine realizes he could also put the money in savings for one year. If he does this, then in one year's time he would have _____ more dollars, which would allow him to purchase _____% more kW/hr. (Assume that the price change for kW/hr reflects the general inflation rate; kW/hr can be priced in thousandths of a dollar; you can purchase only part of a kW/hr.)

6, 2 The increase in Jermaine's purchasing power is implied by the Fisher equation: real interest rate = nominal interest rate - inflation rate.

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

Correct Answer(s): - Inflation increases while the real interest rate remains constant. Using the Fisher equation, we can see that a constant real interest combined with higher inflation is equivalent to a higher nominal interest rate. - Inflation increases from 2% to 5%, while the real interest rate increases from 0% to 3%. The nominal interest rate starts at 2% (= 0% + 2%) and ends up at 8% (= 5% + 3%). - Inflation drops by 2 percentage points, while the real interest rate increases by 3 points. The rise in the real rate outweighs the drop in the inflation rate. The nominal interest rate rises 1 percentage point. Incorrect Answer(s): - Inflation drops by 3 percentage points, while the real interest rate increases by 1 point. The drop in inflation outweighs the rise in the real interest rate. The nominal interest rate drops 2 percentage points. Incentives regarding saving and borrowing impact the interest rate by affecting the supply and demand curves in the market for loanable funds.

Which of the following people are displaying strong time preferences? A. Betsy contributes the maximum amount allowed by the law into her 401(k) amount each year. B. John orders a new video game from an online retailer. Rather than wait for standard shipping, he pays extra for overnight delivery. C. Melissa desperately needs a new car. She can afford the car she wants, but she knows if she waits six months, it will drop in price. She decides to wait six more months rather than buying the car now. D. Travis pays more in income taxes than he needs to each year. Rather than ask his employer to withhold less from his paychecks, he prefers to file for a refund each spring to recoup his taxes.

John orders a new video game from an online retailer. Rather than wait for standard shipping, he pays extra for overnight delivery. Strong time preferences indicate that people greatly prefer to have what they want sooner rather than later. That is certainly the case for John and his video game.

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.

Orange line shifts to the left, On X-Axis I shifts left, On Y-Axis R shifts up As the boomers withdraw their savings, the supply of loanable funds decreases. The supply curve shifts, and interest rates rise.

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

increase foreign wealth and income 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.

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 Since savings must equal investment, every dollar borrowed requires a dollar saved.

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%. Assuming Loni considers only the expenses and revenues described above, should she take the loan and build the app?

no The expected return on Loni's investment is $99,000 - $87,000 = $12,000. However, in addition to repaying the loan amount, she must also pay $87,000 × 0.15 = $13,050 in interest. Therefore, the expected return on her investment is less than the interest on the loan.

Imagine you save $1,724.00 for one year at a simple interest rate of 4% paid yearly. How much would your deposit increase to by the end of the year?

$1,792.96 $1,724 plus 4% of $1,724 would equal $1,792.96.

Place the following items in order from lowest to highest according to the real interest rate.

1. nominal interest rate = 0% inflation rate = 3% 2. nominal interest rate = 10% inflation rate = 8% 3. nominal interest rate = 3% inflation rate 0% 4. nominal interest rate = 22% inflation rate = 16% real interest rate = -3% real interest rate = 2% real interest rate = 3% real interest rate = 6% The real interest rate is the interest rate that borrowers and savers primarily care about. It is equal to the nominal interest rate minus the inflation rate.

The graph below depicts the market for loanable funds. Complete the graph by labeling the supply and demand curves and the y-axis of the graph. Y-Axis: contains percentages X-Axis: Savings and investment Blue line: goes downward, "D=_____" Orange line: goes upward, "S=_____"

Y-Axis = interest rate D = investment Borrowers, who include governments as well as firms planning to make investments, make up the demand side of the loanable funds market. S = savings Savers, who include private individuals as well as foreign entities, make up the supply side of the loanable funds markets. Just as with any other price, we can analyze movements in the interest rate using the supply-demand framework.

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 investment decisions made on the basis of _____ factors, which he spoke of as resulting from "animal spirits," as determinants of confidence.

capital productivity, future, irrational Capital productivity is critical because firms will not invest unless the expected return, which depends on capital productivity, exceeds the interest rate on the funds for the investment.

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

less, borrow. repay loans, dissave

Going to college means that you give up income in the present so that you earn more in the future. In this sense, college students are _____ patient than those who work instead. Economists would say this is an expression of _____ time preferences.

more, weaker Education choices involve many trade-offs. One trade-off is between working for a given salary now versus earning less now but earning more in the future.

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 buildings and machines and equipment, unless they can borrow first. Therefore, without this market, many firms could not get started.

loanable funds, revenue, investments The loanable funds market is a key element in a healthy economy. Without a well-functioning loanable funds market, future GDP dries up.

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.

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

False 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.

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.

Graph with the Orange line shifting to the left. orange line labeled "S####", arrow going up on Y-Axis, arrow going left on X-Axis Because investors lacked confidence, they demanded fewer loanable funds. The demand curve shifted, and interest rates dropped.

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.

Helene should take the loan and buy the land.. The expected return on her investment is greater than the interest rate on the loan. Profit minus interest expense will net Helene $300 annually.

Match the appropriate label to each event. I. Trade tensions create worry regarding the future of economic growth. II. A new government in Canada creates worry regarding the future of several free trade agreements. III. City regulations reduce the profitability of new rental apartments. IV. After U.S. quarterly GDP repeatedly exceeds expectations, businesses become more optimistic about future earnings. V. A new 18-wheel truck is so fuel efficient that many truckers find it profitable to replace their trucks.

I. decreased investor confidence Decreased investor confidence reduces the demand for loanable funds. II. Empty III. decreased productivity of capital Decreased building of new rental units will reduce the demand for loanable funds. IV. increased investor confidence Increased investor confidence raises the demand for loanable funds. V. increased productivity of capital Increased truck-replacement activity will raise the demand for loanable funds. Productivity of capital and investor confidence are two critical determinants of the demand for loanable funds.

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?

Interest rates fell. A decrease in the demand for loanable funds tends to lower interest rates, while a decrease in supply tends to raise them.

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: - age distribution of the population The tendency to smooth consumption, combined with changes in the proportion of the population at various stages in the lifetime income cycle, can shift the supply of loanable funds. (The borrowing that is associated with the early phase of consumption smoothing adds to the demand side of the loanable funds market, and does not directly affect supply.) - consumption smoothing The tendency to smooth consumption, combined with changes in the proportion of the population at various stages in the lifetime income cycle, can shift the supply of loanable funds. (The borrowing that is associated with the early phase of consumption smoothing adds to the demand side of the loanable funds market, and does not directly affect supply.) - income When current income changes, both savings and current consumption are affected. - time preferences Changes in the strength of the preference to consume sooner rather than later will affect the amount saved at any interest rate. - wealth When wealth changes, the amount of money potentially available for savings does as well. Affect the Demand Curve: - investor confidence When firms see (or think they see) opportunities to use money to increase sales in the future by investing, their demand for loanable funds goes up. - productivity of capital If capital is more productive, the demand for loanable funds increases. In addition, anything that changes the quantity of savings at any interest rate is a determinant of loanable funds supply.

One line in the graph below describes a typical individual's lifetime pattern of income. The other line describes the typical lifetime pattern of consumption. Label the two lines, keeping in mind the concept of consumption smoothing. Y-Axis: Income consumption X-Axis: point in life

Blue line = consumption The consumption line is less variable, or "smoother," than the income line. Green line = income Income tends not to be "smooth" over the course of one's lifetime. A person with this pattern of income and consumption will borrow early in life, save during the prime earning years, and dissave in later life.

The graph below illustrates equilibrium in the market for loanable funds. Place the labels on the correct areas on the graph. Y-Axis = Interest rate X-Axis = Savings and investments

Blue line = investment Investment is the purchase of capital (buildings and equipment). Companies borrow to finance investment. It represents the demand for loanable funds, and falls as the interest rate rises. Red line = savings Savings are income left over after taxes and consumption, deposited in a financial institution. Savings represents the supply of loanable funds, and rises as the interest rate rises. Vertical dotted line on x-axis = quantity of investment at equilibrium The quantity of money demanded and supplied are equal at an interest rate that satisfies both borrowers and lenders. By convention, it is shown on the x axis. Horizontal dotted line y-axis = interest rate at equilibrium The interest rate in the loanable funds market indicates the price of money borrowed expressed as a percentage of money borrowed per year. By convention, it is shown on the y axis. Equilibrium in the loanable funds market occurs at an interest rate at which investors agree to borrow as much money as savers are willing to save, at that rate of return on their savings.

Place the following actions on the correct areas on the production timeline, according to when they would need to occur.

Borrow → invest → Produce → sell output Borrowing takes place before investing in materials, as investment involves purchasing the capital that the company uses to manufacture. Investment is the purchase of buildings and equipment (capital), so it must take place after borrowing and before production. Production can take place only after buildings and equipment have been invested in and workers have been hired, both of which must take place after borrowing money. The last step in this timeline is to sell what is produced so as to be able to pay for the resources used in producing it; inasmuch as the money to temporarily fund production was borrowed, this means paying the financial institution from which the money was borrowed. In order to produce a product, a firm or company must borrow, which involves presenting its operating plans to a lending institution. It then prepares for production by investing (purchasing or building a building and equipment) and hiring workers. Once it is able to produce, it sells its product and repays its lenders.

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

Cause(s): - a crash in the value of wealth held in real estate and stock markets This decrease in wealth would tend to decrease the supply of loanable funds. - a population boom generation entering its prime earning years More people are entering a phase of life characterized by saving than are leaving that phase, so the number of savers (and, therefore, the supply of loanable funds) increases. Not a Cause: - a collapse of a prominent foreign investment market This would affect the demand curve for loanable funds. - an increase in the interest rate of 3 percentage points The interest rate is the "price" in the loanable funds market, so it would increase quantity supplied but would not shift the supply curve.

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 foreign sales? Click on the correct curve.

Click far left blue line labeled "D3" If businesses become pessimistic, investors will decrease their demand for loanable funds. Conversely, more optimistic investors would increase their demand for loanable funds.

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. Y-Axis = Interest rate X-Axis = Savings (billions of dollars)

Click middle orange line labeled "S1" When interest rates change, the quantity supplied slides along the supply curve for loanable funds. The supply curve doesn't shift.

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. Y-Axis: Interest rate X-Axis: Savings (billions of dollars)

Click on purple line on the far right labeled "S2" An increase in foreign wealth and income increases the quantity saved at any interest rate. The U.S. financial market attracts foreign savings because it is often considered less risky than other global markets.

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.) Y-Axis: Interest rate X-Axis: Investment (billions of dollars)

Click on the blue line on the far right labeled "D2" If businesses become optimistic about future consumer demand, due to higher employment rates, investors will increase their demand for loanable funds. Conversely, more pessimistic investors would decrease their demand for loanable funds.

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. Y-Axis: Interest rate X-Axis: Savings

Click orange line located in the middle labeled "S1" When interest rates change, the quantity supplied slides along the supply curve for loanable funds. The supply curve doesn't shift.

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.

Click space right after 2005 Negative inflation is known as deflation. Recall that the Fisher equation tells us the real interest rate = nominal interest rate - inflation rate.

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. By the Fisher equation, the combination of the two factors would tend to cause a strong decrease in the real interest rate. The rate paid by banks reflects the nominal rate. - Inflation increases, while the nominal interest remains the same. Using the Fisher equation, we see that constant nominal interest combined with higher inflation is equivalent to lower real interest. Incorrect Answer(s): - Interest paid by banks goes up, while inflation remains the same. The Fisher equation implies that with inflation staying the same, the real interest rate will rise if the nominal interest rate rises. The rate paid by banks reflects the nominal rate, which is increasing here and not decreasing. - The nominal interest rate and the inflation rate drop by the same number of percentage points. Since the real interest rate is the difference between the nominal rate and inflation, the real interest rate would not change. Incentives regarding saving and borrowing impact the interest rate, by affecting the supply and demand curves in the market for loanable funds.

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

Correct Answer(s): - a decrease in capital productivity If the demand for loanable funds falls, then both the equilibrium interest rate and the quantity of investment will fall. - a decrease in investor confidence If the demand for loanable funds falls, then both the equilibrium interest rate and the quantity of investment will fall. Incorrect Answer(s): - a decrease in domestic income and wealth If the supply of loanable funds falls, the equilibrium interest rate will increase and the quantity of investment will fall. - a strengthening of time preferences Stronger time preferences would yield less willingness to save at any interest rate, so the equilibrium interest rate would increase and the quantity of investment would fall.

Why is interest typically paid on a loan?

Correct Answer(s): - to compensate the lender for temporarily making do without the money that was lent In making a loan, the lender incurs opportunity costs, because of the other things the lender could have done with the money instead. - to compensate the lender for the risk that the loan will not be repaid If the lender makes many loans, some will not be repaid or will be repaid only after the lender takes extra collection steps. Those are costs the lender has to cover. Incorrect Answer(s): - o compensate the borrower for borrowing from a specific lender Interest is paid from a borrower to a lender. - to ensure that people do not borrow money without having a good reason Interest payments exist for the benefit of lenders, not for the benefit of borrowers.

Match each economic actor with the primary role it plays in the loanable funds market in the United States. I. mutual funds II. foreign entities III. households IV. companies/firms V. banks

I. financial institutions Mutual funds sometimes place excess savings of households or others into the stock or bond market, or money market funds. II. savers In the United States, foreign governments and companies are primarily placing excess savings; in some other countries, foreign entities may be primarily borrowers. III. savers Households are a major source of loanable funds. IV. borrowers Companies borrow from the loanable funds market in order to pay for buildings and equipment (capital), which is the definition of investment. V. financial institutions Banks are a major financial intermediary, turning households and other deposits into loans for companies and governments. A saver is placing leftover earnings after taxes and after consumption in some financial vehicle, a borrower is using savers' money as provided through a financial intermediary (primarily to purchase buildings and equipment, or capital), and a financial intermediary is an institution that takes deposits from households and others and, with that money, makes loans.

Match each of the following terms to the phrase that best describes it. I. what a person depositing money at a bank expects to be paid in return for letting the bank use that money II. the difference between the interest a bank charges borrowers and the interest it pays on deposits III. what a firm is willing to pay a bank in order to have more money to expand

I. interest rate as a reward for saving This is the quoted rate on bank loans. II. a service fee for connecting savers and borrowers This is one way that the bank makes money. III. interest rate as a cost of borrowing This is the quoted rate paid on deposits. Savers and borrowers, interacting in the market for loanable funds, determine the interest rate.

Match each event to its effect on the equilibrium interest rate and the amount of investment in the loanable funds market. I. Immediate consumer gratification is no longer preferred by people. II. A wave of retirees stops working and begins drawing on retirement savings. III. An efficient new source of energy effectively increases the return on owning a factory. IV. Firm owners expect reduced sales in the future.

I. lower interest rate, greater investment Since people are more patient and willing to save, the supply of loanable funds will increase. II. higher interest rate, less investment The retirees' actions cause a decrease in the supply of loanable funds. III. higher interest rate, greater investment Since capital is more productive, firms are more willing to borrow and the demand for loanable funds will increase. IV. lower interest rate, less investment Since investors are more pessimistic about the future economic environment, the demand for loanable funds decreases. At the equilibrium interest rate, total savings is equal to total investment. Each of these scenarios represents either a shift in demand or supply of loanable funds.

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. I. saving II. dissaving III. borrowing

I. prime earning years During their prime earning years, individuals save in anticipation of lower income and retirement. II. later life Individuals who saved are able to consume more than they earn during the relatively low- or zero-income period later in life. III. early life During this relatively low-income phase of life, individuals borrow in anticipation of future, higher income. Borrowing and saving as described in this problem is known as "consumption smoothing," and is one of the factors that causes a shift in the supply of loanable funds.

Apply the correct label to each description. I. a measure of the true purchasing power of savers' return from savings II. III.

I. real interest rate II. interest rate The rate may be real or nominal, depending on whether or not it is adjusted for inflation. III. nominal interest rate Firms and households care about real interest rates but must deal in nominal interest rates for most financial transactions. Nominal interest rates are clear-cut: a bank can promise to pay a certain nominal rate and then do so. Real interest rates vary with inflation, and inflation cannot be measured in real time. (It is hard to measure precisely, even when looking back.) But real interest rates measure real changes in purchasing power and are in that sense a truer measure of what invested money is earning.

Match each term to the phrase that best describes it. I. a willingness to save now and consume later II. evidence that households want their consumption to be more consistent than their income III. withdrawing funds from one's previously accumulated savings IV. a preference for consuming now rather than saving for later

I. weak time preference Think of someone with weaker time preferences as relatively patient. II. consumption smoothing If people did not care about the timing of consumption, would they have any reason to engage in consumption smoothing? III. dissaving Dissaving and borrowing are both ways to consume beyond your current income. IV. strong time preference Think of someone with stronger time preferences as relatively impatient. Time preferences and consumption smoothing are among the reasons the households borrow and save.

Identify whether the following factors that shift the supply of loanable funds increase or decrease the supply of loanable funds.

Increase(s) Supply of Loanable Funds: - increases in wealth As wealth increases, people on average have more money available for savings. - more people in midlife When people are in midlife, they are likely to have the highest earnings of their lives. Decrease(s) Supply of Loanable Funds - decreases in income As income increases, people on average have more money left after tax and after consumption available for savings. - increases in time preferences Time preferences refers to a desire to spend income sooner rather than later; as it increases, savings decreases. - more retired people After retirement people draw down their savings. Factors that increase the supply of loanable funds include wealth, income, and people who are in midlife. Factors that decrease the supply of loanable funds include time preferences and people after retirement.

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 Sam and Simon both have strong time preferences, but Simon is likely in his prime earning years, whereas Sam is more likely to expect a future increase in income. Also, Sam's income is slightly lower, and therefore he will have less money to set aside. Simon and Steve are the same age and have the same salary, but Steve has weaker time preferences than Simon, so we'd expect him to save more. Steve is the same age as Jamie and has the same time preferences, but his lower-income means he can afford to save less. Jamie has a higher income than Sam, Simon, and Steve and can therefore afford greater savings (plus he is at least as patient as everyone else, and he is in his prime earning years). A person's savings rate is a function of how much he or she wants to save; how much income he or she makes, so that some of it could potentially be set aside; and what the individual expects his or her future income and expenses to look like.