Topic 10 Consumption, Saving and Investment

Topic 10 Consumption, Saving and Investment - Topic 10...

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Topic 10 Investment, Consumption, and Saving
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The Loanable Funds Market The market for loanable funds is the aggregate of all the individual financial markets. Funds that Finance Investment Funds come from three sources: 1. Household saving S 2. Government budget surplus ( T G ) 3. Borrowing from the rest of the world ( M X )
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The Real Interest Rate The nominal interest rate is the number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent. For example, if the annual interest paid on a $500 loan is $25, the nominal interest rate is 5 percent per year. The Loanable Funds Market
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The real interest rate is the nominal interest rate adjusted to remove the effects of inflation on the buying power of money. The real interest rate is approximately equal to the nominal interest rate minus the inflation rate. For example, if the nominal interest rate is 5 percent a year and the inflation rate is 2 percent a year, the real interest rate is 3 percent a year. The real interest rate is the opportunity coast of borrowing. The Loanable Funds Market
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The market for loanable funds determines the real interest rate, the quantity of funds loaned, saving, and investment. We’ll start by ignoring the government and the rest of the world. The Demand for Loanable Funds The quantity of loanable funds demanded depends on 1. The real interest rate 2. Expected profit The Loanable Funds Market
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The Demand for Loanable Funds Curve The demand for loanable funds is the relationship between the quantity of loanable funds demanded and the real interest rate when all other influences on borrowing plans remain the same. Business investment is the main item that makes up the demand for loanable funds. The Loanable Funds Market
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Interest Rate-Investment Relationship The investment decision is made on the comparison of expected rate of return (marginal benefit) and the interest rate (marginal Cost). In making investment decision: R > I: investment will be undertaken R < I: do not pursue the investment
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Expected rate of return is found by comparing the expected economic profit (Total revenue Total cost) to cost of investment. The real interest rate represent either the cost of borrowing funds or the opportunity cost of investing your own funds. Interest Rate-Investment Relationship
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