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Module 29

loanable funds market
a hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
rate of return
the profit earned on the project expressed as a percentage of its cost.
crowding out
occurs when a government deficit drives up the interest rate and leads to reduced investment spending.
fisher effect
an increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged.
use a diagram of the loanable funds market to illustrate the effect of the following events on the equilibrium interest rate and quantity of loanable funds.
a. an economy is opened to international movements of capital, and a capital inflow occurs
b. retired people generally save less than working people at any interest rate. The proportion of retired people in the population goes up.
explain what is wrong with the following statement: “savings and investment spending may not be equal in the economy as a whole in equilibrium because when the interest rate rises, households will want to save more money than businesses will want to invest.”
we know from the loanable funds market that s the interest rate rises, households want to save more and consume less. But at the same time, an increase in the interest rate lowers the number of investment spending projects with returns at least as high as the interest rate. The statement “households will want to save more money than businesses will want to to invest” cannot represent an equilibrium in the loanable funds market because it says that quantity of loanable funds offered exceeds the quantity of loanable funds demanded. If that were to occur, the interest rate would fall to make the quantity of loanable funds offered to equal to the quantity of loanable funds demanded.
Suppose that expected inflation rises from 3% to 6%
a. how will the real interest rate be affected by this change?
b. how will the nominal interest rate be affected by this change?
c. what will happen to the equilibrium quantity of loanable funds?
a. the real interest rate will not change. According to the Fisher effect, an increase in expected inflation drives up the nominal interest rate, leaving the real interest rate unchanged.
b. the nominal interest rate will rise by 3%. Each additional percentage point of expected inflation drives up the nominal interest rate by 1 percentage point.
c. as long as inflation is expected, it does not affect the equilibrium quantity of loanable funds. Both the supply and demand curves for loanable funds are pushed upward, leaving the equilibrium quantity of loanable funds unchanged.
a business will decide whether or not to borrow money to finance a project based on a comparison of the interest rate with _____ from its project.
a. expected revenue
b. profit
c. rate of return
d. cost of generated
e. demand generated
c. rate of return
the real interest rate equals the
a. nominal interest rate plus the inflation rate
b. nominal interest rate minus the inflation rate
c. nominal interest rate divide by the inflation rate
d. nominal interest rate ties the inflation rate
e. federal funds rate
b. nominal interest rate minus the inflation rate
which of the following will increase the demand for loanable funds?
a. federal government budget surplus
b. an increase in perceived business opportunities
c. a decrease in the interest rate
d. positive capital inflows
e. decreased private saving rates
b. an increase in perceived business opportunities
which of the following will increase the supply of loanable funds?
a. an increase in perceived business opportunities
b. decreased government borrowing
c. an increased private saving rate
d. an increase in the expected inflation rate
e. a decrease in capital inflows
c. an increased private saving rate
both lenders and borrowers base their decisions on
a. expected real interest rates
b. expected nominal interest rates
c. real interest rates
d. nominal interest rates
e. nominal interest rates minus real interest rates.
a. expected real interest rates

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