Econ Chapter 9
Explain why without a well-functioning loanable funds market, future GDP dries up
-future GDP depends on spending today for necessary resources -this spending comes before any revenue is gained from the sale of output -therefore, firms must borrow in order to generate future GDP (this is why the loanable funds market is so important to the entire economy)
List some household suppliers of loanable funds
-if you have a checking or savings account at a bank -household savings in retirement accounts -stocks -bonds -mutual funds
In a loanable funds market: -good -price -demanders (consumers) -suppliers (sellers)
-loanable funds -interest rate -borrowers who want to invest -savers
What are 3 factors that shift the supply curve for loanable funds? (when these factors change, what happens?)
1) income and wealth 2) time preferences 3) consumption smoothing (when these factors change, the supply curve shifts)
Why do we use the nominal interest rate? (2 reasons)
1) the nom interest rate is the stated interest rate - the rate you read about and consider in actual financial transactions 2) low and steady inflation means that the difference between real and nom interest rates doesn't fluctuate much
Interest rates on savings accounts in the US today are typically less than:
2%
Equilibrium helps to clarify an important principal:
Investment requires saving because every dollar borrowed requires a dollar saved
Output (GDP) requires _________, ___________ requires ___________, _________ requires __________. (what do they all require?)
Output (GDP) requires investment, investment requires borrowing, borrowing requires savings. (all the links in this chain require a loanable funds market that efficiently channels funds from savers to borrowers)
Irving Fisher
The economist who formulated the relationship between inflation and interest rates The fisher equation is named after this dude
if a relatively large population group moves out of the prime earning years and into retirement, the supply of loanable funds will ______
decrease (this is whats happening in the US right now)
Every dollar borrowed, requires a
dollar saved (without savings we cannot sustain future production)
Describe a typical economic life cycle (income)
early in life income levels are low income generally rises through midlife (prime earning years) as people near retirement, their income levels fall again
The loanable funds market, like other markets, naturally tends to move toward ________, where:
equilibrium, where supply = demand
Primary borrowers of loanable funds
firms (in this chapter)
The demanders/borrowers of loanable funds include:
firms and governments
Financial markets are where:
firms and governments obtain financing or funds for their operations (these funds come primarily from household savings across the economy)
Explain why without savings, the economy cannot grow
for an economy to grow overtime, someone has to invest in capital that helps to produce more in the future but investment requires savings
Investment in capital yields ________ _______, which in turn ______ the _________ _____ _______
greater returns; increases the demand for loans
The higher the interest rate, the __________ is the incentive to ________.
greater; save
The nominal interest rate
is the interest rate before it is corrected for inflation, it is the stated interest rate
The real interest rate
is the interest rate that is corrected for inflation, it is the rate of return in terms of real purchasing power
The loanable funds market
is the market where savers supply finds for loans to borrowers
Strongest time presences = Weaker time presences =
least patient people person has more patience
The US financial markets are often considered ____ ___ than other global markets because: (so therefore....)
less risky, the size and relative robustness of the US economy (therefore, as global economies have grown, there has been an increase in foreign savings in the US)
While we recognize that savers and borrowers care about the real interest rate, the current inflationary environment throughout much of the developed world leaves us:
little to no gain by focusing on the real interest rate
In economics, we analyze financial market in the context of:
loanable funds market
Explain what happened from 1980 to 2007 when real estate and stock market values rose significantly
many people shifted their personal savings into these assets (recognizing these alternative paths to future wealth) result: the personal savings rate, as officially measured, plummeted
If time preferences increase, people will become _____ _____, which will ________ the supply of loanable funds
more impatient; reduce
The fact that you are a college student demonstrates that you are:
more patient than some others who chose instead to work for more income now
If peoples time preferences fall, if they become _____ _______, the supply of loanable funds will __________ (increase/decrease)?
more patient; increase
Consumption smoothing
occurs when people borrow and save to smooth consumption over their lifetime (is accomplished with the help of the loanable funds market)
Dissaving
occurs when people withdraw funds from their perviously accumulated savings
If a significant portion of the population leaves the prime earning years at the same time:
overall savings will fall
Because people have time preferences, someone must:
pay them to save
Example of people with very strong time preferences:
people may not go to college, since the returns to getting a college education are not typically realized until years later (time spent in college is time that could have been spent earning income)
Almost all interest rates in the US economy are determined _________ by
privately, the market forces of supply and demand
Lower interest rates lead to a greater
quantity demanded of loanable funds
List gains not counted in personal savings
real estate gains, the gains from purchases of stocks and bonds
Time preferences
refers to the fact that people prefer to receive goods and services sooner rather than later
Midlife or the prime earning years is the time to:
repay loans and save for retirement (during this period the income line exceeds the consumption line and people save)
Profit-maximizing firms borrow to fund an investment if and only if the expected __________ _____ ______ ____________ is:
return on the investment is greater than the interest rate on the loan
All else equal, people with strong time preferences _______ _____ than people with weaker time preferences
save less
If todays working Americans are more focused on instant gratification, they:
save less
The supply of loanable funds might decrease: if income and wealth decline, people will:
save less across all interest rates
As nations gain wealth, they:
save more
In a loanable funds market "Supply" =
savings
What constitutes the supply of loanable funds?
savings
Equilibrium occurs when:
savings = investment
While time preferences are generally ______ over time, if the rate of time preference in a society changes, what happens?
stable, the supply of loanable funds shifts
The loanable funds market includes places like:
stock exchanges, investment banks, mutual fund firms, and commercial banks
The lower the interest rate, the more likely a business will:
succeed in earning enough to exceed the interest it will owe at the end of the year
The fisher equation states
that the real interest rate equals the nominal interest rate minus the inflation rate
"If a significant portion of the population leaves the prime earning years at the same time overall savings will fall" -this is the current situation in the US because:
the baby boomers are now retiring from the work force
For borrowers the interest rate is
the cost of borrowing
Changes in capital productivity shift
the demand for loanable funds
If capital productivity or investor confidence falls:
the demand for loanable funds falls from D1 to D3
The level of demand for loans depends on
the productivity of capital
2 factors that cause shifts in the demand for loanable funds
the productivity of capital investor confidence
What is the loanable funds version of the law of supply?
the quantity of savings rises when the interest rate rises
What gives us the positive relationship between the interest rate and savings? Where is it reflected?
the quantity of savings rises when the interest rate rises reflected in the slope of the supply curve (S)
When making decisions about saving and borrowing, people care about __________ not ________
the real interest rate not the nominal interest rate
If you are a saver, the interest rate is:
the return you get for supplying funds
What is the importance of some foreign funds entering the US financial markets?
their presence will allow more opportunities for domestic firms to borrow for investment than if firms relied solely on domestic savers
When the quantity of loanable funds supplied exceeds the quantity demanded:
this imbalance leads to downward pressure on the interest rate
When the quantity demanded exceeds the quantity supplied:
this imbalance leads to upward pressure on the interest rate
Savers and borrowers care about real rate of interest on a loan because
this is the rate that describes how their funds' real purchasing power changes over the course of the loan
Who are the suppliers of funds and list the 2 included
those who save (Savers) include households and foreign entities
Where savers bring funds and make them available to borrowers
The market for loanable funds
Over the next 10-15 years US workers will enter retirement in record numbers. This means what?
an exit from the prime earning years and, consequently, much less savings
Define households
are private individuals and families (primary suppliers of loanable funds)
What gives us the negative relationship between the interest rate and quantity demanded of loans? Where is it reflected?
as the interest rate drops = larger quantity of loans demanded reflected in the slope of the demand curve (D) for loanable funds
Equilibrium in the loanable funds market occurs:
at the interest rate where the plans of savers match the plans of borrowers (where quantity supplied equals quantity demanded)
The demand for loanable funds also depends on the _______ or _______ of the investors at business firms
beliefs or expectations
When we are young we often: When we retire:
borrow and spend more than we are earning our income levels fall but spending doesn't fall by the same amount
If confidence is high, firms are more likely to:
borrow for investment at any interest rate
When capital is more productive, firms are more likely to:
borrow to finance purchases of this type of capital
Because the interest rate is a result of supply and demand in the market for loanable funds, _______ inflation rates lead to ______ ________ ______ ______ to:
higher inflation rates lead to higher nominal interest rates to compensate lenders for the loss of purchasing power
If a relatively large portion of the population moves into midlife, when savings is ________, this will __________ (increase/decrease) savings from S1 to S2.
highest; increase
We can rewrite the Fisher equation to see:
how inflation generally increases nominal interest rates
How can we use supply and demand to study the loanable funds market?
if we acknowledge that an interest rate is just the price of loanable funds, we can use supply and demand to reveal factors that make interest rates rise and fall
Define foreign entities
include foreign governments, firms and private citizens that chose to save in the US
An increase in foreign income and wealth will _________ (increase/decrease) what?
increase the supply of savings
If investor confidence rises, demand for loanable funds ____ from
increases from D1 to D2
If capital productivity increases, demand for investment _______ from
increases from D1 to D2 (demand is higher across all interests rates)
Increases in income generally produce: ______________ If income declines, people: ______ ______ These changes do what?
increases in savings save less shift the loanable funds supply curve
If capital is more productive, the demand for loans ______; if capital is less productive, the demand for loans __________
increases; decreases
For a given real interest rate, the higher the rate of _________, the higher the _______ _______ _____ will be
inflation, nominal interest rate
A price of loanable funds
interest rate
Thought of as "the opportunity cost of consumption"
interest rate
The higher the ________ ________ the greater the _________ will be in the future
interest rate; return
Firms borrow to ________, to __________________. Firms looking to ___________ must ________________.
invest, buy tools and equipment and build factories produce output in the future must borrow to pay their expenses today
In a loanable funds market "Demand" =
investment
Borrowing fuels _____, which creates _________ ________.
investment; future output
When the overall economy slows, firms often reduce ___________, since they expect reduced sales in future periods; this move reflects what?
investment; reflects a decline in investor confidence
In order to make _________, firms must ______ since they have ___ ___________ yet.
investments; borrow; no revenue
If a firm believes sales will increase in the future, it will:
invests more today to build for future sales (if it believes its future sales will fall, it invests less today)
investor confidence
is a measure of what firms expect for future economic activity
Interest rate
is a price of loanable funds, quoted as a percentage of the original loan amount
The Savings Rate
is personal saving as a portion of disposable (after-tax) income
If we have a steady flow of people moving into each stage of life, the amount of savings in the economy:
is stable and there will be a steady supply in the market for loanable funds
