Overview of Behavioral Economics

• Interest in how people behave in economic contexts

• Emphasis on behavioral economics and financial market decisions

• The journey to becoming an economist typically begins in college, rather than high school

Economics in College

• Distinction between analytical and behavioral approaches to economics

• Different departments may focus on various aspects:

  • Analytical focus: Accounting and Finance

  • Behavioral focus: Marketing, General Business

• Necessary coursework includes both macro and microeconomics

• Importance of exploring personal interest and options (e.g., choosing a minor) in college

Loanable Funds Market

Introduction

• Aim to understand the equilibrium in the loanable funds market, starting with demand shifts and equilibrium concepts

• Objectives: To grasp how various economic changes affect equilibrium in the market

Recap of Previous Class (Supply Side)

Key Concepts

• Factors influencing the supply side of the market:

  • Change in wealth influences savings capacity

  • Wealth increases (e.g., good stock market performance) lead to increased savings

  • Increased savings shift supply of loanable funds right, decreasing interest rates

Demand Side of the Loanable Funds Market

Shift Factors for Demand

1. Productivity of Capital

   • Definition: Productivity of the tools or equipment used for production

   • Example scenario: Opening an ice cream shop requires investment in capital (e.g., ice cream machines).

   • Comparison of capital productivity:

     • Old-fashioned churn (less productive)

     • Modern machine (more productive)

   • Higher productivity leads to increased willingness to borrow, shifting demand curve to the right

2. Investor Confidence

   • Definition: A measure of expectations about future economic conditions

   • Borrowing decisions based on expected return vs interest rate

   • Examples of investor perspectives, affecting demand:

     • Optimism about economic recovery increases demand for capital

     • Pessimism reduces it

   • Business Confidence Index: A tool for measuring business confidence over time

3. Government Borrowing

   • Governments as major borrowers in the market

   • Independent of interest rates; often set spending priorities regardless of those rates

   • Increase in government borrowing shifts demand curve right

   • Decrease in government borrowing shifts demand curve left

Equilibrium Concept

Supply and Demand Interaction

• The equilibrium point is found where supply equals demand for funds:

  • Dollar values borrowed equal dollar values saved

• Factors leading to shifts in demand or supply will affect equilibrium:

  • Example: Baby boomers retiring will likely decrease supply of funds (shift left), raising interest rates while decreasing quantity available for investment.

Government Borrowing Example: COVID-19 Impact

• Increased government borrowing during COVID-19 crisis

• Shifts demand curve right, raising interest rates while increasing the quantity of funds available for borrowing.

Shifts in Equilibrium

• Case Study: Growing investor confidence

  • Initial equilibrium established:

  • Drawing initial curves and points

  • Evaluating shift in demand curve for confident investors

  • Results in increased interest rates and investment levels

Graphical Representations

• Interpreting shifts in demand/supply curves:

  • Importance of drawing accurate initial curves and labeling axes clearly

  • Identifying new equilibrium after a shift occurs

Financial Instruments

Types of Finance

• Indirect Finance

  • Involves intermediaries (e.g., banks) between savers and borrowers

  • Banks accept deposits, issue loans, and facilitate monetary transactions

• Direct Finance

  • Direct transactions between savers and borrowers without intermediaries

  • Example: Personal loans or issuing bonds directly to investors

Understanding Bonds

Basic Definitions

• Bond: Financial security representing debt

• Maturity Date: Date when bond must be repaid

• Face Value (Par Value): Value of the bond upon maturity

• Coupons: Interest payments before maturity

Types

• Zero Coupon Bonds: Pay the face value at maturity with no interim interest payments

Pricing and Yield

- Bond Prices: Generally lower than face value due to default risks and opportunity costs of other investments

Interest Rate Calculation for Bonds

• Formula: Interest Rate = (Face Value - Price) / Price

• Calculating yield for various bond prices (e.g., how price affects yield)

• The relationship between riskiness of investment and resulting interest rates, emphasizing potential high yields on high-risk bonds

Conclusion

• Understand how each aspect of the loanable funds market interacts through both individual behavior and broader economic influences.

• Explore financial securities like bonds to understand fundamental economic principles at play.