ECON 101: Chap. 4.2: Demand and Supply in Financial Markets

Financial Capital

• Savings make up the supply

• Labour and capital are the two main resources that an economy needs to produce the goods and services

• Includes: physical assets, machinery, buildings, trucks, and highways that are necessary for production

• Money lent and borrowed for production is called “capital”

Caveat

• “let him or her beware”

• Formal notice or warning

Savers

• called investors or financial investors

Borrowers

• business investors

• Entrepreneurs

• Needs money for a start up

Interest Rate

The “price” of borrowing money the return to capital investment

Demand and Supply for Borrowing Money with Credit Cards

• at an above-equilibrium interest rate, the quantity of financial capital supplied would increase, but quantity demanded would decrease

• at a below-equilibrium interest rate, the quantity of financial capital demanded would increase, but quantity of financial capital supplied would decrease

Intertemporal Decision Making + Its Factors

• a process when savers (financial investors) need to make decisions between today and the future - decision whether to consume today or save money

• Factors:

  • expectations about future earnings (retirement)

  • expectations about future events (sickness, accidents, or other losses)

  • saving money for some future big expenses (dream vacation, weddings)

  • Income

Rate of Return and Risk

• two attributes savers need to consider

• usually low-risk investments come with low rate of return

• high-risk investments come with high rate of return

Financial Decisions Across Time (graph)

• upward sloping of supply financial capital (lending money) is a saver’s behaviour of intertemporal decision making

• a lender is a consumer who decides to pospone part of consumption in order to save money

• when borrowers compete for existing funds, the interest rate a saver (lender) requests increases beyond the inflation

• lenders save and lend less when interest rate in market is low; they save and lend more when interest rates are high

• borrowers can borrow more when interest rate is low; and they borrow less when interest rates are high

Effect of Growing Government Debt

• Governments are amongst the largest borrowers in financial market, which makes budget deficits have the power to influence the interest rate

• when outside investors slowly stop in an economy with increasing public debt, the supply of financial capital diminishes, shifting the supply of funds other than the left