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    ECO 304L - 9

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    ECO 304L - 9

    Uploaded by

    madisongracewu
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    3 views2 pages

    ECO 304L - 9

    Uploaded by

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    © All Rights Reserved
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    of 2

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

    What is the loanable funds market?


    - loanable funds market – market where savers supply funds for loans to borrowers
    - firms must borrow money in order to generate future GDP

    - without savings, we cannot sustain future production


    - output (GDP) requires investment, investment requires borrowing, borrowing requires
    savings
    Interest Rates as a Reward for Saving
    - interest rate – a price of loanable funds, quoted as a percentage of the original loan
    amount; reward for savers
    - the higher the interest rate, the greater incentive to save (positive relationship)
    Interest Rates as a Cost of Borrowing
    - expected return – anticipated rate of return based on the probabilities of all possible
    outcomes
    - for borrowers, the interest rate is the cost of borrowing, firms only borrow if the expected
    return on their investment is greater than the cost of the loan (negative relationship –
    lower interest rates lead to a greater quantity demanded of loanable funds)
    How Inflation Affects Interest Rates
    - real interest rate – interest rate corrected for inflation, rate of return in terms of real
    purchasing power
    - nominal interest rate – interest rate before it is corrected for inflation, stated interest rate
    - Fisher equation → real interest rate = nominal interest rate – inflation rate
    What factors shift the supply of loanable funds?
    1. Income and Wealth
    - as people gain wealth, they save more
    - been an increase in saving from foreign countries/individuals
    2. Time Preferences
    - time preferences – people prefer to receive goods and services sooner rather than
    later
    - people with stronger time preferences (want it now) save less than people with
    weaker time preferences
    3. Consumption Smoothing
    - consumption smoothing – occurs when people borrow and save to smooth
    consumption over their lifetime, accomplished with the help of the loanable funds
    market
    - dissaving – people withdraw funds from their previously accumulated savings
    - supply increases when large portion of the population moves into midlife (when
    savings is the highest)

    What factors shift the demand for loanable funds?


    1. Productivity of Capital
    - impacts if the return is going to outweigh the cost
    - productivity can change because of technology etc.
    2. Investor Confidence
    - investor confidence – measure of what firms expect for future economic activity
    - high confidence increases their likelihood of borrowing for investment
    3. Government Borrowing
    - increases in government borrowing are reflected as increases in the demand for
    loanable funds → shifts demand curve to the right
    - decreases in government borrowing lead to leftward shifts in demand
    How do we apply the loanable funds market model?
    Equilibrium → savings = investment
    - occurs at the interest rate where the plans of savers match the plans of borrowers
    (quantity supplied = quantity demanded, accounting for interest!)
    A Decrease in the Demand for Loanable Funds
    A Decrease in the Supply of Loanable Funds

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