Chapter 9: Savings, Interest Rates, and the Market for Loanable Funds

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?

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

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%

Which of the following could explain the increase in Americans' personal savings rate during the first few months after the March 2020 lockdown began?

-Households experienced economic uncertainty. -The country experienced mandated statewide closures of non-essential businesses and continued closure of large-gathering events.

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

-Inflation increases, while the nominal interest remains the same. -Inflation rises, while interest paid by banks drops.

Ceteris paribus, which of these events would not cause both the equilibrium interest rate and the equilibrium quantity of investment to fall?

-a decrease in domestic income and wealth -a strengthening of time preferences

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

-a decrease in investor confidence -a decrease in capital productivity

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

-a population boom generation entering its prime earning years -a crash in the value of wealth held in real estate and stock markets

Which of the following events would not cause the supply of loanable funds to shift?

-an increase in the interest rate of 3 percentage points -a collapse of a prominent foreign investment market

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

Why is interest typically paid on a loan?

-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

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.

1. 2005 2. 2011 3. 1975

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

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%

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.)

3, 2

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

3.2%

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%

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%

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%

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%

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. Inflation increases from 2% to 5%, while the real interest rate increases from 0% to 3%. Inflation drops by 2 percentage points, while the real interest rate increases by 3 points.

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

False

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

Which of the following people are displaying strong time preferences?

John orders a new video game from an online retailer. Rather than wait for standard shipping, he pays extra for overnight delivery.

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.

S2020 line moves left <-

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.

S=saving D=investment y-axis=investment

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.

Sam, Simon, Steve, Jamie

The graph depicts the U.S. nominal interest rate and real interest rate between 1965 and 2020. Keeping in mind the Fisher equation, select the time period during which the inflation rate briefly turned negative.

between 2005 and 2010

companies/firms

borrowers

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

evidence that households want their consumption to be more consistent than their income

consumption smoothing

Affect the Supply Curve

consumption smoothing income time preferences wealth age distribution of the population

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.

green arch= income smooth arch= consumption

An efficient new source of energy effectively increases the return on owning a factory.

higher interest rate, greater investment

A wave of retirees stops working and begins drawing on retirement savings.

higher interest rate, less investment

savers

households, foreign entities

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

After U.S. quarterly GDP repeatedly exceeds expectations, businesses become more optimistic about future earnings.

increased investor confidence

A new 18-wheel truck is so fuel efficient that many truckers find it profitable to replace their trucks.

increased productivity of capital

Increase(s) Supply of Loanable Funds

increases in wealth more people in midlife

financial institutions

banks, mutual funds

Trade tensions create worry regarding the future of economic growth.

decreased investor confidence

City regulations reduce the profitability of new rental apartments.

decreased productivity of capital

Decrease(s) Supply of Loanable Funds

decreases in income more retired people increases in time preferences

At the start of the 2020 pandemic-induced recession, firms responded to the economic uncertainty by - their - for investment funds.

decreasing, demand

withdrawing funds from one's previously accumulated savings

dissaving

During the three most 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 would provide the strongest evidence that it was a fall in the demand for, and not a reduction in the supply of, loanable funds that caused decreased investment during these three recessions? Use the model of the loanable funds market to help you.

interest rates fell

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

Immediate consumer gratification is no longer preferred by people.

lower interest rate, greater investment

Firm owners expect reduced sales in the future.

lower interest rate, less investment

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

more people in midlife increases in wealth

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

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

nominal interest rate = 0% inflation rate = 3% nominal interest rate = 10% inflation rate = 8% nominal interest rate = 3% inflation rate = 0% nominal interest rate = 22% inflation rate = 16%

Affect the Demand Curve

productivity of capital investor confidence

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.

saving: prime earning years dissaving: later life borrowing: early life

a preference for consuming now rather than saving for later

strong time preference

a willingness to save now and consume later

weak time preference

Match each of the following terms to the phrase that best describes it.

what a person depositing money at a bank expects to be paid in return for letting the bank use that money interest rate as a reward for saving Correct label: interest rate as a reward for saving what a firm is willing to pay a bank in order to have more money to expand interest rate as a cost of borrowing Correct label: interest rate as a cost of borrowing the difference between the interest a bank charges borrowers and the interest it pays on deposits a service fee for connecting savers and borrowers Correct label: a service fee for connecting savers and borrowers