Macro Notes.docx - Ch 9 Savings Interest and the Market for...

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Ch. 9 Savings, Interest, and the Market for Loanable FundsThe Loanable Funds Market-The financial system has a very important role of channeling funds from one place to another-Parts of the financial system:oStock exchangesoInvestment banksoCommercial banks-Through the F.S., firms, corporations, and governments borrow funds from house-holds who provide their saved money-F.S. links borrowers (firms and gov.) to savers (household)oThey have projects but need money to finance themoMost house-holds save portions of their income for the future, typically at banksNotes About Borrowing-Firm’s ability to borrow and raise money is important for physical capital accumulationoMost firms need huge sums of money to expand, build, and purchase equipment-Every advanced economy has a well-developed F.S. and this is key to economic growthInterest Rates-The price of loanable fundsoSavers: the reward for savingoBorrowers: the cost of borrowing-Affected by supply and demandLoanable Funds “law of supply”-The quantity of savings rises when the interest rate increases-If you lower the interest rates, firms likely to borrow more moneyReal Interest Rate-Interest rate corrected for inflation (R.I.R.=nom. I.R. – inflation rate)
Nominal Interest Rate-Interest rate before correcting (Nom I.R. = real I.R. + inflation rate)Demand for Loanable Funds-Demanders of loanable funds are borrowersoDemand is driven largely by firms that need to borrow for large capital projectsoGovernments also borrow-RecalloBorrowing must occur to build capital goodsoSo, anything that changes firms’ desire to build capital goods, changes their desire to borrow fundsWhat Factors Shift the Demand of Loanable Funds?-Shift in the demand of loanable funds caused by:oChanges in the productivity of capitaloChanges in businesses confidenceoGovernment borrowingShifts in the Demand for Loanable Funds-Productivity of Physical CapitaloIf physical capital becomes more productive, the demand for funds will increaseoThe returns on current physical investment will be greateroExample: Fracking and transformation of oil industry-Business ConfidenceoIf a firm is optimistic, it will borrow more today-Government borrowing needsoDepends on the level of spending and budget deficit/surplusoBudget Deficit: spending exceeds tax revenues during a yearoBudget Surplus: tax revenue exceeds spending oIncrease in budget deficits increases government borrowing needs, thus shifting demand for funds right
Equilibrium in the Market for Loanable Funds-In equilibrium: savings=investmentoSupply of loanable funds in savingsoDemand for loanable funds depends on firms wanting to borrow in order to invest in physical capital-Relationship between saving and borrowingoEvery dollar borrowed requires a dollar saved-Accumulation of physical capital on any nation depends on how much of its resident’s saveChanges in Equilibrium-Case 1: Decline in business confidence due to economic slowdowno

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