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Economics 4-1

If the federal government taxes the interest rate that savers receive
the supply of loanable funds decreases
The interest rate is
the price of loanable funds
You borrow some amount of money for five years at a fixed rate of 4%. For the first three years, inflation is 3%, and for the last two years, deflation is 3%. Based on this information
your real rate of interest was larger than your nominal rate only for the last two years
Every ____________ requires a ____________
investment dollar; savings dollar
A bond is an instrument that allows the bearer to earn interest. The bearer would be best described as
a supplier of loanable funds
If life expectancy falls due to AIDS and other diseases, we would expect
time preference to rise and savings to decrease
Savings is
the supply of loanable funds and is upward sloping
In the following scenario, identify whether the supply or demand curve shifts in the loanable funds market, and in what direction
supply curve shifts left
A young girl is saving money for a soccer ball but is tempted to buy a book. If the girl buys a book rather than continuing to save for the ball
the girl has exchanged low time preferences for high
Firms expect more sales and profits in the near future; this would cause
the demand for loanable funds to increase
You borrow $10,000 today at a nominal rate of 5%; inflation for the past 10 years has been exactly 2%. Today, inflation instantly rises to 4% and stays that way for the duration of your loan. Based on the above information and all else being equal, today
you are better off because you are paying back the loan with dollars that represent less purchasing power today than the dollars you borrowed before
Inflation reached its peak (of at least 14%) in the late 1970s/early 1980s. If this statement is true, then
it is certain the nominal rate of interest was greater than the real rate
Suppose that you want to start a business and need to finance the capital. What channel(s) in the loanable funds market could you use
A and B
A – Direct finance
B – Indirect finance
The measurement of personal savings may be distorted by
greater levels of home equity
If foreign income and wealth decrease, this would most likely
cause the supply of loanable funds to decrease
The demand for loanable funds increases while the supply of loanable funds remains constant. This would cause
both the equilibrium quantity of loanable funds and the equilibrium interest rate to increase
Assume households become thriftier. This would cause
the supply of loanable funds to increase
Assume that two people save $100 per month (the same for both) and earn exactly the same positive annual interest rate of 2%. Also assume that one of them started saving at 20 years old, while the other stared saving at 40 years old. Which statement is correct
On their 60th birthday, the one who started saving later would have less than half the amount that the one who began saving earlier has
By 1981
interest rates were about 15%
A young boy is saving money for a baseball bat but is tempted to buy an ice cream cone. If the boy successfully resists buying ice cream and continues to save for the bat
the boy has exchanged high time preferences for low
What factor(s) shift the supply curve of loanable funds
Income and wealth
When people withdraw funds from their savings, economists call this
dissaving
Every dollar borrowed
requires a dollar to be saved
Peoples’ largest asset is usually their homes. Homeownership is a means of saving money for the future. If people have more equity in their homes, it is the same as if
savings has increased
If interest rates fell between 1981 and 2012, then
quantity demanded of loanable funds increased
Which of the following is an example of direct finance?
I. Apple stocks
II. Microsoft bonds
III. A savings account in Citibank
i and ii
An increase in the interest rate will result in an increase in the
quantity supplied of loanable funds and movement up along the supply curve of loanable funds
If foreign entities save more and businesses become more optimistic about the future, we would correctly say that
the new equilibrium quantity of loanable funds would increase, but we would be unable to tell if the new equilibrium interest rate would be higher or lower than the original
Most people have a time preference. Since this is true
they must be paid interest to consume later (save now) and are willing to pay interest to consume now (save later)
If real rates were higher than nominal rates in 2009, the implication is that
inflation was negative (deflation was occurring)
Which combination of events could have caused the equilibrium interest rate to rise and the equilibrium quantity of loanable funds (both borrowed and lent) to fall
A baby boom begins, and people have higher time preferences
Equilibrium in the loanable funds market means
the interest rate at which investment equals savings
Lenders in the loanable funds market consist of
households and foreign entities
The gap between the real and nominal interest rate represents
the inflationary premium
Typically a college degree is “worth it,” but it requires
low time preferences
Assume an epidemic hits a nation hard. As a result, people now have lower life expectancies. The most likely result would be: (hint: the period of mid-life will be shorter)
a lower supply of loanable funds
Assuming inflation is positive, the real interest rate
must always be smaller than the nominal interest rate
Assume foreign incomes rise. Ceteris paribus (all things equal), this would cause
the supply of loanable funds to increase
If household wealth rises and capital becomes less productive, we would correctly say that
the new equilibrium quantity of loanable funds would be indeterminate, but we would be certain the new equilibrium interest rate would be less than the original
Which of the following reflects an accurate economic chain of events
Savings finances investment, which allows the economy to grow from a larger capital stock
The presence of secondary markets ______________ the interest rates that firms have to pay on bonds issued by them
decreases
The demand for loanable funds increases while the supply of loanable funds simultaneously decreases. This would cause
the equilibrium interest rate to increase, but the new equilibrium quantity would be uncertain
You borrow $10,000 today at a nominal rate of 5%; inflation for the past 10 years has been exactly 2%. Today, inflation instantly rises to 7% and stays that way for the duration of your loan. Based on the above information, ceteris paribus (all else equal), today
the real rate of interest on your loan is now -2%
The interest rate represents _________ to _________ and _________ to _________
the cost of borrowing; firms and governments; a reward to saving; households
The notion of the loanable funds market is
the method by which savers (typically households and individuals) supply funds to borrowers (typically firms)
Businesses became more pessimistic during the Great Recession of 2007-2009. As a result
investment demand fell
You deposit $500.00 into an asset that pays 10% annual interest for three years. At the end of the three years, you would have
$665.50
Suppose that capital becomes more productive. What would we expect to happen
The equilibrium interest rate and amount invested would both increase
Keynes used the term “animal spirits” to describe peoples’ feelings on the economy. If everyone began feeling better about the economic future
“animal spirits” would become more positive and firms would invest more, causing the demand for loanable funds to increase
You are thinking about buying a new car and will borrow $20,000 for this purchase at a 5% fixed rate for exactly one year. The lender (correctly) assumes that inflation will be 2% this year. Based on the above information and assuming you adhere to the terms of the loan
you will pay back the lender exactly $21,000, which will represent $20,600 of purchasing power
As income and wealth rise, we would expect
savings to increase as people save some of the extra wealth or income they have
Your roommate arrives home and says, “I am so hungry, I would give up my iPhone for a bowl of chili right now.” You say, “Here is the chili—let’s trade.” Based on this information
you have a lower time preference than your roommate because he gets the chili now
Two nations are located next to one another. In Nation A, people are very thrifty and spend much less than their incomes; moreover, Nation A’s government runs a balanced budget every year. In Nation B, people spend all of their income, but their government runs consistent deficits. Thus
Nation A’s extra savings would increase the supply of loanable funds to Nation B
You deposit $1,000.00 in the bank and leave it for five years at 3% annual interest making no additional transactions on this account. At the end of the five years, you withdraw the principal and any accumulated interest; the amount you would withdraw would be
more than $1,150.00 but less than $1,500.00
If interest rates rise
firms are willing to borrow less money because their cost of borrowing has increased
Smiley Myrus owns a large corporation that is building a new shopping mall in Winston-Salem, North Carolina. In all likelihood
Smiley’s firm is a borrower of loanable funds
Borrowers in the loanable funds market consist of
governments and firms
An increase in the supply of loanable funds means
savers want to save more at every interest rate
The supply of loanable funds increases while the demand for loanable funds remains constant. This would cause
the equilibrium quantity of loanable funds to increase and the equilibrium interest rate to decrease
The government
is a net borrower (or demander of loanable funds)
The largest inflationary gap appeared
at the end of the 1970s and in the early 1980s
The notion of compound interest means that
if you leave a lump sum (some dollar amount) in the bank for some period, it will accumulate interest both on the principal and on any accumulated interest
We could best describe
the real rate of interest as the inflation-adjusted rate of interest
You are an entrepreneur about to start your first business. Based on this statement
you are most likely to be a borrower concerned mostly about the real interest rate you will pay
The correct production timeline is
dollars are borrowed, investment occurs, and output is produced
Higher education
will generally result in higher lifetime earnings, ceteris paribus (all else equal)
In exchange for savings, borrowers issue _____
stocks and bonds
The demand for loanable funds increases by the exact same percentage that the supply of loanable funds decreases. This would cause
the equilibrium interest rate to increase, but the equilibrium quantity would remain unchanged
____________ are on the demand side and _____________ are on the supply side of the loanable funds market
Firms and governments; households
Automobile manufacturers are planning to adopt a new technology that will increase their overall productivity by 30%. As a result, the amount of equilibrium investment will ________________ and equilibrium interest rate will _________________ in the loanable funds market
increase; increase
What’s happened to the savings rate in the U.S. since 1980
Savings are lower now than in 1980
when making decisions about saving and borrowing, people care most about
the real rate of interest
You deposit $600 in a savings account in your bank for a year. By the end of the year the value of your deposits increases to $625. What is the interest rate that your bank is offering on the savings account
4.16%
Imagine you live on the planet Krypton. The loanable funds market on Krypton is thriving and life is good. However, the planet is very, very old and the great scientists and philosophers on the planet have begun discussing openly that the planet may be on the verge of destruction. Even if the great thinkers are wrong, the loanable funds market will change in the short term. Specifically, the supply of loanable funds is expected to ____________ and as a result the amount of economic output in the future is expected to _______________
fall; decrease
Time preferences mean
people prefer goods sooner rather than later
If foreign entities save less and governments run more deficits, we would correctly say that
the new equilibrium quantity of loanable funds would be indeterminate, but we would be certain the new equilibrium interest rate would be higher than the original
What factor(s) affect the demand loanable funds
Productivity of capital
It is likely that as more baby boomers reach retirement
the supply of loanable funds will shift left
If interest rates rise, holding all else constant, this would cause
an increase in the quantity supplied of loanable funds but a decrease in the quantity demanded of loanable funds
Which description best indicates a fall in interest rates
This would be shown by a downward movement along both the demand and supply curves for loanable funds
How do we describe it when a person who’s 45 years old saves a large amount of her income for retirement
Consumption smoothing
If the U.S. economy experiences a major recession, then
the demand for loanable funds will shift left
What occurs when the loanable funds market is in equilibrium
Savings = Investment
The demand and supply of loanable funds decrease simultaneously. This would cause
the equilibrium quantity of loanable funds to decrease, but the effect on the equilibrium interest rate would be uncertain
Foreign entities
are generally lenders in the domestic (U.S.) loanable funds
Based on the relationship between consumption and income, someone in their “prime earning years”
is most likely a saver
One could correctly argue that higher capital productivity
would increase the value of capital and the demand for loanable funds
Melvin begins his retirement fund at age 30, depositing $1,000 per month until age 50. Cindy begins her retirement fund at age 20, depositing the same $1,000 per month amount until age 50. Both Melvin and Cindy earn 5% annual interest on their funds, and there are no tax considerations in this problem. Based on the provided information
and assuming they retire at age 50, Cindy will have more than 50% more than Melvin
Typically, savers in the loanable funds market are the _________, and borrowers are _________
households and foreign entities; firms and the (U.S.) government
Assume the market for loanable funds is in equilibrium at 5% interest. Assuming that firms become more pessimistic about future profits, all else being equal
both the equilibrium interest rate and the equilibrium quantity would fall
Put the phrases in order from first to last to best illustrate the progression of a properly functioning loanable funds market
Borrowing requires saving; investment requires borrowing; output (GDP) requires investment
First comes savings, then investment, then GDP grows
Suppose the country of Sylvania experienced a striking increase in its birth rates in the 1970s. Thus, an increasing part of the population of Sylvania entered in midlife around 2001. Which of the following figures correctly depicts the change in savings behavior in Sylvania in 2001?
Fig. 4
If a depositor puts money in the bank, the interest rate that the bank will pay the depositor:
is the nominal rate of interest.
The concept of the loanable funds market is:
the market by which lenders (savers) and borrowers exchange funds for earlier availability at a premium, which is represented by the interest rate
Which combination of events could have caused the equilibrium interest rate to fall and the equilibrium quantity of loanable funds (both borrowed and lent) to fall?
Firms are more pessimistic, and governments run fewer deficits.
Those with the least patience:
have the greatest time preference.
Assume inflation is occurring in a nation; the implication(s):
is that the nominal interest rate exceeds the real interest rate
Use the Fisher equation to fill in the blanks in the following table.
Inflation rate: ; 2% ; 2%
Real interest rate: 2% ; ; 2%
Nominal interest rate: 7% ; 6%
Inflation rate, 5%; Real interest rate, 4%; Nominal interest rate, 4%
Many interest rates in the United States recently fell. Which of the following factors could have been the cause?
decrease in the demand for loanable funds; increase in the supply of loanable funds
Foreign entities:
are generally lenders in the domestic (U.S.) loanable funds
The government engages in more deficit spending. Ceteris paribus (all else equal), this would cause:
the demand for loanable funds to increase.
In the market for loanable funds, _____ flow to borrowers from banks.
loans
You are thinking about building a new mall. Your economic consultants say the mall will bring a 7% rate of return. Because you know that you can borrow money for 5%:
assuming conditions don’t change, you will build the mall no matter how much it costs
The interest rate represents
the opportunity cost of consumption.
You work as a consultant to firms deciding whether to borrow funds to invest in new projects. For each of your clients listed in the table, suppose that you have determined the interest rate they can borrow at, and also the expected rate of return on their investment. Which of these firms should you tell to go ahead with their investment?
the candy company; the café; the soccer team
Savings represents:
the supply of loanable funds.

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