Module 8-Loanable Funds

What is the primary role of household savings in the economy?

Household savings feed into the economy and contribute to physical capital, which is necessary for GDP in the long run.

What does the loanable funds market illustrate?

It illustrates the relationship between saving and investment, affecting real interest rates and the quantity of loanable funds.

What is the formula for available physical capital in year t?

Kt+1 = Kt + Investment t - Depreciation t

What is the significance of GDP per capita in relation to investment rates?

Countries with higher investment rates tend to have higher GDP per capita.

What are the two types of finance mentioned in the financial system?

Indirect finance and direct finance.

What is indirect finance?

A flow of funds from savers to borrowers through financial intermediaries such as banks.

What is direct finance?

A flow of funds from savers to firms through financial markets, such as the New York Stock Exchange.

What is a bond?

A certificate of indebtedness that specifies obligations of the borrower to the holder of the bond.

What is a coupon payment?

A payment on a bond, representing the interest rate for the issuer.

What factors determine interest rates in the bond market?

Term, credit risk, repayment time, and the amount of the loan.

What is stock in the context of the financial system?

A claim to partial ownership in a firm and a claim to the profits that the firm makes.

What are dividends?

Payments made by a corporation to its shareholders.

What is the role of mutual funds?

They sell shares to the public and use the proceeds to buy a diversified portfolio of stocks and bonds.

How do banks operate within the financial system?

Banks take deposits from savers and use those deposits to make loans to borrowers.

What is national saving?

The total income in the economy that remains after paying for consumption and government purchases.

What is the equation representing total income in a closed economy?

Y = C + I + G

What does the left side of the equation Y - C - G represent?

National savings (S), which is the total income after consumption and government purchases.

What are the determinants of the supply and demand for loanable funds?

Factors that affect real interest rates and the quantity of loanable funds available for saving and investment.

What is the impact of a higher investment rate on economic growth?

Higher investment rates typically lead to greater economic growth and improved GDP per capita.

What is the relationship between bond prices and interest rates?

Bond prices and interest rates are negatively correlated.

What is the significance of credit risk in the bond market?

It represents the probability that the borrower will fail to pay some of the interest or principal.

What is the effect of longer loan terms on interest rates?

Longer loans typically result in higher interest rates.

What does the term 'growth miracles' refer to?

Periods of significant economic growth, often associated with high investment rates.

What does 'growth disasters' refer to?

Periods of economic stagnation or decline, often linked to low investment rates.

What are the main stock exchanges in the United States?

The New York Stock Exchange, the American Stock Exchange, and NASDAQ.

What is the role of financial intermediaries?

They borrow funds from savers and lend them to borrowers, facilitating the flow of funds in the economy.

What is private saving?

The amount of income that households have after receiving transfers from the government, paying taxes, and paying for consumption. Formula: Private saving = (Y + TR - T - C)

Define public saving.

The amount of tax revenue that the government has left after paying for its spending and transfers. Formula: Public Saving = (T - G - TR)

What is a budget surplus?

When public saving is positive, calculated as Budget Surplus = (T - G - TR)

What is a budget deficit?

When public saving is negative, calculated as Budget Deficit = (G + TR - T)

What determines the real interest rate in the loanable funds market?

The equilibrium of the supply and demand for loanable funds determines the real interest rate.

What happens to the equilibrium real interest rate when demand for loanable funds increases?

It increases the equilibrium real interest rate and the equilibrium quantity of loanable funds.

What happens to the equilibrium real interest rate when supply of loanable funds increases?

It decreases the equilibrium real interest rate and increases the equilibrium quantity of loanable funds.

What are some supply shifters in the loanable funds market?

Income, cost, population, wealth, expected future income, interest rates, confidence, and taxes.

What are some demand shifters in the loanable funds market?

Expectations of future profitability, technology, business taxes, and cash flow.

How does an investment tax credit affect the demand for loanable funds?

It increases the demand for loanable funds, leading to a higher interest rate and increased saving and investment.

What is present value?

The amount of money today needed to produce a given future amount using prevailing interest rates. It demonstrates that receiving money now is preferred to receiving the same amount in the future.

What is the formula for present value?

Present Value = Future Value / (1 + r)^N, where r is the interest rate and N is the number of years.

What does discounting refer to in finance?

The process of finding a present value for the future amount, as the possibility of earning interest reduces the present value below the future value.

When should you choose a lump sum payment over structured payments?

Choose a lump sum if the time is shorter or the expected rate of return is higher.

What is the effect of a federal budget deficit on the supply of loanable funds?

It decreases the supply of loanable funds, leading to an increase in interest rates.

How does a tax on consumption affect the supply of loanable funds?

It increases the supply of loanable funds, resulting in a decrease in interest rates.

What was the change in the quantity of loanable funds from 2018 to 2019?

The quantity rose from $3.9 trillion to $4.0 trillion, while the interest rate fell from 2.91% to 2.14%.

What is the relationship between gross saving and the level of saving and investment?

An increase in gross saving explains why the level of saving and investment increased while the interest rate decreased.

What is crowding out in the context of loanable funds?

A decline in private expenditures as a result of an increase in government purchases via deficits.

What is the impact of an increase in income on interest rates, savings, investment, and borrowing?

An increase in household income typically leads to higher savings and investment, which can affect interest rates.