Exhaustive Guide to Money Functions, Loanable Funds, and Crowding Out

Comparative Market Analysis: Money Market vs. Reserve Market * The presenter highlights a key distinction for examination preparation between the Money Market graph and the Reserve Market graph. * Money Market Graph: Used to demonstrate the results of open market operations (buying or selling bonds) on nominal interest rates. * Reserve Market Graph: Used to demonstrate changes in the interest on reserves ($IOR$). * Reserve Categories: The speaker notes that the instructional video provides a better explanation regarding "ample" versus "limited" reserves. * Study Resources: Reference is made to bank balance sheets, specifically a "really good one" found in the "ultimate review packet." # The Three Functions of Money * Money serves three primary roles in an economy: * Medium of Exchange: This means money is used specifically to buy goods and services. This is identified as the most frequently tested function on the exam. * Unit of Account: This is the standard numerical unit of measurement for value and costs of goods, services, assets, and liabilities. * Store of Value: This function involves the ability of money to be saved, retrieved, and exchanged at a later time, and be predictably useful when retrieved. * Exam Note: The terms "medium of exchange," "unit of account," and "store of value" appear verbatim on the test, even though they may seem formal or unusual in common speech. # The Loanable Funds Market * Conceptual Basis: This market represents the supply and demand for loans. * Variables of the Graph: * Vertical Axis: Represented by the Real Interest Rate ($r\%$). * Horizontal Axis: Represented by the Quantity of Loanable Funds ($Q$). * Demand Side Analysis: * Borrowers are the primary demanders of loans. * Factors increasing demand: Higher expectations of profit due to an economy growing and decreases in business taxes. * Tax implications: Changes in capital gains taxes also affect the demand for borrowing. * The relationship is inverse: as the real interest rate falls, the quantity of loans demanded increases ($P \downarrow, Q_d \uparrow$). * Supply Side Analysis: * Savers and lenders provide the supply of loanable funds. * The relationship is direct: as the real interest rate increases, the quantity of loans supplied increases ($P \uparrow, Q_s \uparrow$). * Exam Strategy: The speaker notes that the AP test is typically very specific regarding events; students do not have to guess. If an event affects savers or lenders, it is a supply shift; if it affects borrowers, it is a demand shift. # Crowding Out and Fiscal Policy * Definition of Crowding Out: This phenomenon occurs when government deficit spending forces interest rates upward, thereby reducing (or "crowding out") private investment. * Causes of Deficit Spending: * The government increases spending while keeping taxes constant. * The government implements tax cuts without reducing spending. * Mechanism of Action: When the government borrows to fund its deficit, it enters the loanable funds market. * Graphing Crowding Out: There are two accepted ways to show this on the Loanable Funds Market graph: * Method 1: An increase in the Demand for loanable funds (showing the government as a borrower). * Method 2: A decrease in the Supply of loanable funds (showing the government using up available savings). * Note: The AP test will usually provide instructions on which curve to shift (e.g., "show on the supply of loanable funds what happens"). * Macroeconomic Consequences: * The Real Interest Rate ($r\%$) increases. * Higher interest rates lead to less private investment spending by businesses. * Reduced investment leads to slower capital accumulation and less economic growth in the long run. # Questions & Discussion * Topic Interest: The presenter noted that approximately 18 participants asked specifically about the concept of "crowding out" during the session, indicating it is a priority topic for students. * Visual Clarification: There was an exchange between the presenter and the audience regarding the camera settings. The presenter's internal view appeared reversed (mirror image), leading to concern about whether the graphs ($r\%$ on the vertical axis and $Q$ on the horizontal axis) were legible. The audience confirmed that the graphs looked normal and correct on their screen. * Instructional Aside: The presenter mentioned feeling "old" for using the phrase "pulling my chain" when questioning if the audience was being honest about the camera orientation.