ch_02 - Chapter 2 Determination of Interest Rates Questions...

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Chapter 2 Determination of Interest Rates Questions 1. Explain why interest rates changed as they did over the past year. ANSWER: This exercise should force students to consider how the factors that influence interest rates have changed over the last year, and assess how these changes could have affected interest rates. 2. Explain what is meant by interest elasticity. ANSWER: Interest elasticity of supply represents a change in the quantity of loanable funds supplied in response to a change in interest rates. Interest elasticity of demand represents a change in the quantity of loanable funds demanded in response to a change in interest rates. 3. Would you expect federal government demand for loanable funds to be more or less interest elastic than household demand for loanable funds? Why? ANSWER: Federal government demand for loanable funds should be less interest elastic than the consumer demand for loanable funds, because the government's planned borrowings will likely occur regardless of the interest rate. Conversely, the quantity of loanable funds by consumers is more responsive to the interest rate level. 4. If the federal government planned to expand the space program, how might this affect interest rates? ANSWER: An expanded space program would (a) force the federal government to increase its budget deficit, (b) possibly force any firms involved in facilitating the program to borrow more funds. Consequently, there is a greater demand for loanable funds. The additional spending could cause higher income and additional saving. Yet, this impact is not likely to be as great. The likely overall impact would therefore be upward pressure on interest rates. 5. Explain why interest rates tend to decrease during recessionary periods. ANSWER: During a recession, firms and consumers reduce their amount of borrowing. The demand for loanable funds decreases and interest rates decrease as a result. 6. Obtain or develop forecasts of economic growth and inflation. Use this information to forecast interest rates one year from now. ANSWER: Open-ended question, intended to illustrate the ease of subjectively creating forecasts, but the difficulty in deciding the appropriate weight to be assigned to each influential factor. 7. Jayhawk Forecasting Services analyzed several factors that could affect interest rates in the future. Most factors were expected to place downward pressure on interest rates. Jayhawk also felt that although the annual budget deficit was to be cut by 40 percent from the previous year, it would still be very large. Thus, Jayhawk believed that the deficit's impact would 7
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8   Chapter 2/Determination of Interest Rates more than offset the other effects and therefore forecast interest rates to increase by 2 percent. Comment on Jayhawk's logic. ANSWER: A reduction in the deficit should free up some funds that had been used to
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This note was uploaded on 04/12/2011 for the course ECON 101 taught by Professor Buddin during the Spring '08 term at UCLA.

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ch_02 - Chapter 2 Determination of Interest Rates Questions...

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