week 8 - chp 14

Discussion on Tariffs and Foreign Policy

• The concept of using tariffs as a foreign policy tool is debated.

• Tariffs can serve as threats or hammers in international relations.

• Other countries may respond to tariffs with their own measures, often similar to what they were going to implement anyway.

• There is concern about adopting an adversarial stance in foreign policy, especially with allies like Canada.

• Strategic thinking within tariffs can relate to credibility and game theory in international relations.

Local Funds Model Overview

• The local funds model is crucial for understanding loanable funds, consisting of nine questions per chapter related to new material.

• The model analyzes the connection between savings and investment through a simple supply and demand graph.

Supply and Demand Basics

• Loanable funds: money lent from savers to borrowers.

• Interest rate is the price of borrowed money.

• Higher interest rates encourage saving and discourage borrowing, and vice versa.

• Only one interest rate is considered in this simplified model, ignoring the complexities of banks.

Understanding Interest Rates

• For savers, the interest rate is the return on their savings.

• For borrowers, it represents the cost of borrowing.

• Equilibrium interest rate balances savers and borrowers' actions in the market.

Demand for Loanable Funds

• Demand curve originates from businesses seeking funds for investment and government borrowing.

• Investment decisions depend on the relationship between machine costs and returns based on interest rates.

• A scenario with a 2% interest rate versus a 4% rate influences the decision to invest in machinery.

• As interest rates rise, demand for loanable funds decreases as investment spending diminishes.

The Supply of Loanable Funds

• Supply comes from savings; higher interest rates lead to increased savings.

• Changes in the economy can shift supply to the right (increased savings) or to the left (decreased savings).

Historical Context of Savings Rates

• U.S. savings rates have declined historically, impacting investment levels and personal financial health.

• Societal habits and cultural norms regarding savings have shifted, potentially influenced by generational experiences.

Factors Affecting Loanable Funds

Shifters for Supply of Loanable Funds

1. Wealth: Increased wealth often leads to more savings.

2. Economic Conditions: Recessions reduce savings; good economic times increase savings.

3. Future Expectations: Skepticism leads to increased savings; optimism reduces it.

4. Uncertainty: High uncertainty causes higher savings as people prepare for potential negative outcomes.

5. Borrowing Constraints: Tougher borrowing conditions lead individuals to self-fund by saving more.

6. Government Policies: Changes in social security affect individual saving decisions.

7. Cultural Values: Societal orientation towards future versus present impacts saving behavior.

Shifters for Demand of Loanable Funds

1. Investment Profitability: Expectations of profitable investments increase demand for funds.

2. Economic Optimism: If businesses expect economic growth, demand for investments rises.

3. Government Borrowing: Increased government borrowing directly adds to the demand for loanable funds.

Illustrating Supply and Demand Shifts

• Example scenarios illustrate what happens to equilibrium interest rates when shifts occur in demand or supply.

• Supply and demand curves can shift simultaneously, affecting either equilibrium quantity and/or interest rates ambiguously.

Crowding Out Effect

• Definition: Government borrowing can lead to decreased private sector investment due to increased interest rates from higher demand for funds.

• An increase in government debt skews the balance, forcing businesses to seek financing at higher costs, reducing their investment.

• This is illustrated through graphical representations of shifting demand curves and resulting equilibrium changes in the loanable funds market.

Conclusion and Study Tips

• Understand that the loanable funds market operates like other markets, driven by supply and demand principles.

• Review the shifts of both supply and demand carefully to prepare for potential exam questions.

• Utilize examples to solidify understanding of how various factors affect loanable funds throughout the economy.