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紅石國際教育中心Red Rock Institute Red Rock Institute Red Rock Institute Red Rock Institute & PublishingPublishingPublishingPublishing
Market_for_Loanable_Funds_Chap-9
� We will use a basic Supply and Demand Graph to analyze this market
� The Market for Loanable Funds is NOT a real place.
� It is a composite representation of the financial market/system where:
1. people/businesses/governments WITH money supply it to others, and inreturn get an interest rate they EARN for supplying that money.
2. People/businesses/government s WITHOUT money borrow it from others, and in return get an interest rate they PAY for demanding that money.
2
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
3
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
When Consumers/Businesses or
Governments have surplus
Funds they may want to
Place them in some type of
Savings and/or Investment
4
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
This surplus savings is put
Into the financial system
As a SUPPLY SUPPLY SUPPLY SUPPLY of Loanable
Funds
This surplus savings is put
Into the financial system
As a SUPPLY SUPPLY SUPPLY SUPPLY of Loanable
Funds
5
Real
Interest
Rate
Quantity of Loanable Funds
r
*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
What these savers/investors care about
Is the REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE they will
Earn on their money.
Remember the Real Interest Rate is what
You will earn AFTERAFTERAFTERAFTER inflation is factored
out
6
Real
Interest
Rate
Quantity of Loanable Funds
r
*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
What these savers/investors care about
Is the REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE they will
Earn on their money.
Remember the Real Interest Rate is what
You will earn AFTERAFTERAFTERAFTER inflation is factored
out
What these savers/investors care about
Is the REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE they will
Earn on their money.
Remember the Real Interest Rate is what
You will earn AFTERAFTERAFTERAFTER inflation is factored
out
7
Real Interest Rate = Nominal Interest Rate - Inflation
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
8
The Demand for Loanable Funds comes
From Consumers/Business/Governments
Who donWho donWho donWho don’’’’t have money, t have money, t have money, t have money, but want to borrow
It to finance their purchases
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
9
What these BORROWERS care about
Is the REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE they will
PAY on the money they BORROW.
Remember the Real Interest Rate is what
You will earn AFTERAFTERAFTERAFTER inflation is factored
out
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
10
What these BORROWERS care about
Is the REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE REAL INTEREST RATE they will
PAY on the money they BORROW.
Remember the Real Interest Rate is what
You will earn AFTERAFTERAFTERAFTER inflation is factored
out
Real Interest Rate = Nominal Interest Rate - Inflation
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
The REAL INTEREST RATE is a Long-Term interest
rate that both Borrowers AND savers are going
to consider when making decisions
11
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
12
The Struggle EnsuesThe Struggle EnsuesThe Struggle EnsuesThe Struggle Ensues…………....
Demanders for Loanable Funds desire a
LOWERLOWERLOWERLOWER Real Interest Rate because for :
1. Consumers Consumers Consumers Consumers it makes the purchases of houses,
Cars, Big Screen T.V.’s, etc LESS LESS LESS LESS expensive
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
13
The Struggle EnsuesThe Struggle EnsuesThe Struggle EnsuesThe Struggle Ensues…………....
Demanders for Loanable Funds desire a
LOWERLOWERLOWERLOWER Real Interest Rate because for :
1. BusinessesBusinessesBusinessesBusinesses it makes the purchases of Capital
Goods, expanding facilities, or building new
facilities LESSLESSLESSLESS expensive
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
14
The Struggle EnsuesThe Struggle EnsuesThe Struggle EnsuesThe Struggle Ensues…………....
Demanders for Loanable Funds desire a
LOWERLOWERLOWERLOWER Real Interest Rate because for :
1. BusinessesBusinessesBusinessesBusinesses it makes the purchases of Capital
Goods, expanding facilities, or building new
facilities LESSLESSLESSLESS expensive
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
15
The Struggle EnsuesThe Struggle EnsuesThe Struggle EnsuesThe Struggle Ensues…………....
The SUPPLIERS SUPPLIERS SUPPLIERS SUPPLIERS of Loanable Funds desire a
HIGHERHIGHERHIGHERHIGHER Real Interest Rate because it makes the
Money they saved/invested GROW LARGERGROW LARGERGROW LARGERGROW LARGER.
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
16
Assume the Market for Loanable Funds is
In equilibrium at “r*”. At this Real Interest
Rate Demanders will demand QLF* and
Suppliers will supply QLF*. This is the
Market clearing “price”.
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
17
ASSUMPTIONASSUMPTIONASSUMPTIONASSUMPTION
Assume the U.S. Government pursues an
Expansionary Fiscal Policy that requires it to
Deficit Deficit Deficit Deficit spend (spend MORE than they bring
In in Tax Revenue.
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
18
In order to do this they will need to BORROWBORROWBORROWBORROW
Money (assuming they don’t just print it). The
U.S Government will enter the Market for
Loanable Funds as a DEMANDER DEMANDER DEMANDER DEMANDER (remember,
They don’t have money, they want it).
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
19
This policy will INCREASE INCREASE INCREASE INCREASE the
Demand for Loanable Funds
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
20
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
21
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
The REAL INTEREST RATE INCREASED REAL INTEREST RATE INCREASED REAL INTEREST RATE INCREASED REAL INTEREST RATE INCREASED
Because of Government Deficit Spending!!!
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
22
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
The REAL INTERESTREAL INTERESTREAL INTERESTREAL INTEREST is HIGHER HIGHER HIGHER HIGHER than
Before, so NOW for Consumers and/or
Businesses to BORROW BORROW BORROW BORROW will be MOREMOREMOREMORE
Expensive due to the new Government policy
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
23
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
This reduction in Consumer/Business borrowing because of Govt. deficit spending is
Called ““““THE CROWDING OUT EFFECTTHE CROWDING OUT EFFECTTHE CROWDING OUT EFFECTTHE CROWDING OUT EFFECT”””” of PRIVATE SPENDINGPRIVATE SPENDINGPRIVATE SPENDINGPRIVATE SPENDING. (C + I)
Real
Interest
Rate
Quantity of Loanable Funds
r
*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
24
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
This is illustrated by the difference between the two equilibriuThis is illustrated by the difference between the two equilibriuThis is illustrated by the difference between the two equilibriuThis is illustrated by the difference between the two equilibrium ratesm ratesm ratesm rates
Real
Interest
Rate
Quantity of Loanable Funds
r*
QLF*
Demand for Loanable Funds*
(Consumers/Businesses)
Supply of Loanable Funds*
(Consumers/Businesses/Governments)
Market for Loanable Funds
25
QLF₁
r₁
DLF₁ (Consumers/Businesses AND GOVERNMENT)
How much The Crowding Out Effect The Crowding Out Effect The Crowding Out Effect The Crowding Out Effect impacts
the economy is dependent upon how responsivehow responsivehow responsivehow responsive
Consumers and BusinessesConsumers and BusinessesConsumers and BusinessesConsumers and Businesses are to changes in
The REAL INTERERST RATE
� If consumers and business are HIGHLY responsive to increases in interest rates then the Crowding Out Effect on Govt. spending will be “COMPLETE Crowding Out Effect”
� If consumers and business are partially responsive to increases interest rates then the Crowding Out Effect of Govt. spending will be “Partial Crowding Out Effect”
� If consumers and businesses are NOT responsive to changes in interest rates then there will be No Crowding Out Effect of Govt. spending.
26
Crowding Out Effect
and AD/AS
27
Price
Level
Real GDP
FE
GDP
SRASLRAS
AD*
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy returns
To Full-Employment RGDP
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy returns
To Full-Employment RGDP
RGDP*
PL*
PL₁
AD₁
This would suggest that C + I are NOT RESONSIVE to the INCREASE in the REAL INTEREST
RATE. Borrowing by C + I would not be effected---”NO CROWDING OUT EFFECT”
Actual RGDP = Potential RGDP
Crowding Out Effect
and AD/AS
28
Price
Level
Real GDP
FE
GDP
SRASLRAS
AD*
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy DOES NOT
Return to Full-Employment
RGDP.
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy DOES NOT
Return to Full-Employment
RGDP.
RGDP*
PL*PL₁AD₁
This would suggest that C + I are PARTIALLY RESPONSIVE to the INCREASE in the REAL INTEREST
RATE. Borrowing by C + I would be NEGATIVELY effected---”PARTIAL CROWDING OUT EFFECT”
Actual RGDP < Potential RGDPRGDP₁
Crowding Out Effect
and AD/AS
29
Price
Level
Real GDP
FE
GDP
SRASLRAS
AD*
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy STAYS THE
SAME. Any increase in Govt.
Spending is off-set COMPLETLEY
By the decreases borrowing
By consumers and businesses.
AD/AS is indicating the
Economy is in a severe
Recession. Assume Govt.
Spending INCREASES
(through BORROWING)
And the economy STAYS THE
SAME. Any increase in Govt.
Spending is off-set COMPLETLEY
By the decreases borrowing
By consumers and businesses.
RGDP*
PL*
PL₁
AD₁
This would suggest that C + I are 100% RESPONSIVE to the INCREASE in the REAL INTEREST
RATE. Borrowing by C + I would be 100% NEGATIVELY effected---”COMPLETE CROWDING OUT EFFECT”
Actual RGDP < Potential RGDP
� If Government INCREASES deficit spending and by doing so INCREASES the REAL INTEREST RATE then it may have the following effects:
� No Crowding out effect: Govt. spends and it DOES NOT effect borrowing by C + I and the economy can return to Full-Employment
� Partial Crowding Out: Govt. spends and it DOES effect borrowing by C + I. C + I do not borrow AS MUCH thus potentialLY causing the economy to NOT RETURN TO FULL EMPLOYMENT.
� Complete Crowding Out: Government Spends and it has the effect of causing C + I to NOT borrow and the economy virtually stays the same: NO INCREASE RGDP
30
� If interest rates increase due to Government borrowing AND if it “crowds out” PRIVATE INVESTMENT in the business sector the following could happen:
� Capital projects (expanding facilities, building new facilities) will become less profitable.
� Business will not borrow to replace capital equipment.
� Short term Aggregate Demand will be adversely affected.
� Long Run Aggregate Supply (PPF) will be adversely affected because the CAPITAL STOCK of the economy will become obsolete and/or depleted. Essentially Capital Stock will DECREASE.
31
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