An increase in the real interest rate increases the quantity of loanable funds supplied; a decrease in the real interest rate decreases the quantity of loanable funds supplied.. The equi
Trang 1W H AT I S E C O N O M I C S ? 1 1 9
A n s w e r s t o t h e R e v i e w Q u i z z e s
Page 202 (page 610 in Economics)
1 Distinguish between physical capital and financial capital and give two
examples of each
Physical capital is the actual tools, instruments, machines, buildings and other items that have been produced in the past and are presently used to produce goods and services Financial capital is the funds that businesses use to acquire their physical capital Examples of physical capital are the pizza ovens owned by Pizza Hut and the buildings in which the Pizza Huts are located Examples of
financial capital are the bonds issued by Pizza Hut to buy pizza ovens and the loans Pizza Hut has made to fund their purchases of new buildings
2 What is the distinction between gross investment and net investment?
Gross investment is the total amount spent on new capital; net investment is the change in the value of the capital stock Net investment equals gross investment minus depreciation
3 What are the three main types of markets for financial capital?
The main types of markets for financial capital are the loan markets, the bond markets, and the stock markets
4 Explain the connection between the price of a financial asset and its interest rate
There is an inverse relationship between the price of a financial asset and its interest rate When the price of a financial asset rises, its interest rate falls
Similarly, when the interest rate on an asset falls, the price of the asset rises
Page 209 (page 617 in Economics)
1 What is the loanable funds market?
The loanable funds market is the market in which households, firms, governments, banks, and other financial institutions borrow and lend It is the aggregate of all the individual financial markets and includes loan markets, bond markets, and stock markets The real interest rate is determined in this market
2 Explain why the real interest rate is the opportunity cost of loanable funds
C h a p t e r
119
Trang 21 2 0
The real interest rate is the opportunity cost of loanable funds because the real interest rate measures what is forgone by using the funds If the funds are loaned, then the real interest rate is received If the funds are borrowed, then the real interest is paid for the funds The real interest rate forgone when funds are used either to buy consumption goods and services or to invest in new capital goods is the opportunity cost of not saving or not lending those funds
3 How do firms make investment decisions?
To determine the quantity of investment, firms compare the expected profit rate from an investment to the real interest rate The expected profit from an
investment is the benefit from the investment The real interest rate is the
opportunity cost of investment If the expected profit from an investment exceeds the cost of the real interest rate, then firms make the investment If the expected profit from an investment is less than the cost of the real interest rate, then firms
do not make the investment
4 What determines the demand for loanable funds and what makes it change?
The demand for loanable funds depends on the real interest rate and expected profit If the real interest rate falls and nothing else changes, the quantity of
loanable funds demanded increases Conversely, if the real interest rate rises and everything else remains the same, the quantity of loanable funds demanded decreases Movements along the loanable funds demand curve illustrate these events If the expected profit increases and nothing else changes, the demand for loanable funds increases and the demand for loanable funds curve shifts
rightward If the expected profit decreases and everything else remains the same, the demand for loanable funds decreases and the demand for loanable funds curve shifts leftward
5 How do households make saving decisions?
A household’s saving depends on five factors: the real interest rate, the
household’s disposable income, the household’s expected future income, wealth, and default risk A household increases its saving if the real interest rate increases, its disposable income increases, its expected future income decreases, its wealth decreases, or if default risk decreases
6 What determines the supply of loanable funds and what makes it change?
The supply of loanable funds depends on the real interest rate, disposable income, expected future income, wealth, and default risk An increase in the real interest rate increases the quantity of loanable funds supplied; a decrease in the real interest rate decreases the quantity of loanable funds supplied An increase in disposable income increases the supply of loanable funds; a decrease in
disposable income decreases the supply of loanable funds An increase in wealth decreases the supply of loanable funds; a decrease in wealth increases the supply
of loanable funds An increase in expected future income decreases the supply of loanable funds; a decrease in expected future income increases the supply of loanable funds Finally, an increase in default risk decreases the supply of loanable funds; a decrease in default risk increases the supply of loanable funds
7 How do changes in the demand for and supply of loanable funds change the real interest rate and quantity of loanable funds?
The real interest rate is determined by the supply of loanable funds and the
demand for loanable funds The equilibrium real interest rate is the real interest rate at which the quantity of loanable funds supplied equals the quantity of
loanable funds demanded Changes in the demand for or supply of loanable funds change the equilibrium real interest rate and equilibrium quantity of loanable funds If the demand for loanable funds increases and the supply does not change, the real interest rate rises and the quantity of loanable funds increases If the
120
Trang 3W H AT I S E C O N O M I C S ? 1 2 1
demand for loanable funds decreases and the supply does not change, the real interest rate falls and the quantity of loanable funds decreases If the supply of loanable funds increases and the demand does not change, the real interest rate falls and the quantity of loanable funds increases If the supply of loanable funds decreases and the demand does not change, the real interest rate rises and the quantity of loanable funds decreases
Page 211 (page 619 in Economics)
1 How does a government budget surplus or deficit influence the loanable funds market?
A government budget surplus adds to the supply of loanable funds A government budget deficit adds to the demand for loanable funds
2 What is the crowding-out effect and how does it work?
The crowding-out effect refers to the decrease in investment that occurs when the government budget deficit increases An increase in the government budget deficit increases the demand for loanable funds As a result the real interest rate rises The rise in the real interest rate decreases—“crowds out”—investment
3 What is the Ricardo-Barro effect and how does it modify the crowding-out effect?
The Ricardo-Barro effect points out that the crowding out effect is less than
predicted by looking only at the effect of a budget deficit on the demand for
loanable funds The Ricardo-Barro effect asserts that as a result of a government budget deficit households increase their saving to pay the higher taxes that will be needed in the future to repay the debt issued to fund the deficit The increase in saving increases the supply of loanable funds This increase in the supply of
loanable funds offsets the rise in the real interest rate from the increase in the demand for loanable funds caused by the budget deficit Because the real interest rate does not rise as much, the decrease in investment, that is the amount of crowding out, is less in the presence of the Ricardo-Barro effect
121
Trang 4A n s w e r s t o t h e S t u d y P l a n P r o b l e m s a n d
A p p l i c a t i o n s
Use the following data to work Problems 1 and 2
Michael is an Internet service provider On December 31, 2014, he bought an
existing business with servers and a building worth $400,000 During 2015, his business grew and he bought new servers for $500,000 The market value of some
of his older servers fell by $100,000
1 What was Michael’s gross investment, depreciation, and net investment
during 2015?
Michael’s gross investment was $500,000, his depreciation was $100,000, and his net investment was $400,000
2 What is the value of Michael’s capital at the end of 2015?
Michael’s capital at the end of 2015 is equal to his capital at the beginning of
2015, $400,000, plus his net investment during the year, also $400,000, for a total
of $800,000
3 Lori is a student who teaches golf on Saturdays In a year, she earns $20,000 after paying her taxes At the beginning of 2014, Lori owned $1,000 worth of books, DVDs, and golf clubs and she had $5,000 in a savings account at the bank During 2014, the interest on her savings account was $300 and she spent a total of $15,300 on consumption goods and services There was no change in the market values of her books, DVDs, and golf clubs
a How much did Lori save in 2014?
Lori’s saving equals her disposable income minus her consumption expenditure Lori’s disposable income is $20,000 plus the interest on her savings account, $300, for a total of $20,300.Her consumption expenditure is $15,300, so her saving is
$5,000
b What was her wealth at the end of 2014?
Lori’s wealth at the end of 2014 is equal to the value of her wealth at the
beginning of 2014 plus her saving during the year At the beginning of 2014 Lori’s wealth is $6,000—the value of her books, DVDs, golf clubs, and savings account Lori saved $5,000 during 2014 so her wealth at the end of the year is $11,000
Treasury bond prices rose on Monday, pushing interest rates down The
interest rate on 10-year bonds fell 4 basis points to 1.65%
Source: The Wall Street Journal, August 27, 2012
What is the relationship between the price of a treasury bond and its interest rate? Why does the interest rate move inversely to price?
When the price of a treasury bond rises, its interest rate falls This inverse
relationship exists because of the definition of an interest rate The interest rate equals the amount paid as interest divided by the price of the security, then
multiplied by 100 When the price rises, mathematically the interest rate must fall.
Trang 5Use the following information to work Problems 5 and 6.
First Call, Inc., a smartphone company, plans
to build an assembly plant that costs $10
million if the real interest rate is 6 percent a
year or a larger plant that costs $12 million if
the real interest rate is 5 percent a year or a
smaller plant that costs $8 million if the real
interest rate is 7 percent a year
5 Draw a graph of First Call’s demand for
loanable funds curve
Figure 7.1 shows First Call’s demand for
loanable funds curve
6 First Call expects its profit to double next
year Explain how this increase in
expected profit influences First Call’s
demand for loanable funds
When First Call expects its profit to
increase, First Call increases its
investment The increase in its investment leads First Call to increase its demand
for loanable funds
7 The table sets out data for an
economy when the government’s
budget is balanced
a Calculate the equilibrium real
interest rate, investment, and
private saving
The equilibrium real interest rate
is 7 percent per year The
equilibrium quantity of
investment equals the quantity of
loanable funds demand, $7.0
trillion and the equilibrium
quantity of saving equals the
quantity of loanable funds
supplied, $7.0 trillion
b If planned saving increases by $0.5 trillion at each real interest rate, explain the change in the real interest rate
The increase in saving increases the supply of loanable funds The equilibrium real interest rate falls In the table, the new equilibrium real interest rate is 6.5 percent per year
c If planned investment increases by $1 trillion at each real interest rate,
explain the change in the real interest rate
The increase in investment increases the demand for loanable funds The
equilibrium real interest rate rises In the table, the new equilibrium real interest
rate is 8 percent per year
Real interest rate
Loanable funds demanded
Loanable funds supplied (percent per
year)
(trillions of 2009 dollars)
F I N A N C E , S AV I N G , A N D I N V E S T M E N T 8 9
Trang 6Use the data in Problem 7 to work Problems 8 and 9.
8 If the government’s budget becomes a deficit of $1 trillion, what are the real interest rate and investment? Does crowding out occur?
The equilibrium real interest rate becomes 8 percent and the equilibrium quantity
of investment is $6.5 trillion There is crowding out of $500 billion of investment
9 If the government’s budget becomes a deficit of $1 trillion and the Ricardo-Barro effect occurs, what are the real interest rate and the investment?
The equilibrium real interest rate remains 7 percent and the quantity of
investment remains $7.0 trillion There is no crowding out because the $1 trillion increase in the budget deficit leads to an offsetting $1 trillion increase in private saving
Use the table in Problem 7 and the following data to work Problems 10 and 11 Suppose that the quantity of loanable funds demanded increases by $1 trillion at each real interest rate and the quantity of loanable funds supplied increases by $2 trillion at each interest rate
10 If the government budget remains balanced, what are the real interest rate, investment, and private saving? Does any crowding out occur?
The table to the right, which
shows the new demand for
loanable funds and new supply
of loanable funds schedules, is
helpful to answer the problem
The new real interest rate is 6
percent Investment and private
saving are both $8.5 trillion
There is no crowding out
11 If the government’s budget
becomes a deficit of $1 trillion,
what are the real interest rate,
investment, and private saving?
Does any crowding out occur?
The equilibrium real interest rate becomes 7 percent The equilibrium quantity of investment is $8.0 trillion and the equilibrium quantity of private saving is $9.0 trillion There is crowding out of $500 billion of investment
Real interest rate
Loanable funds demanded
Loanable funds supplied (percent per
9 0 C H A P T E R 7
Trang 7Answers to Additional Problems and Applications
12 On January 1 2014, the London Taxi Company owned 5 cabs valued at
£150,000 During 2014, the London Taxi Company bought 4 new cabs for a
total of £200,000 At the end of 2014, the market value of all of the cabs was
£300,000 Calculate the London Taxi Company’s gross investment,
depreciation, and net investment
Gross investment was £200,000 Depreciation was 200,000 + 150,000 300,000 =
£50,000 Net investment, equal to gross investment minus depreciation, was
£150,000
Use the following information to work Problems 13 and 14
The Bureau of Economic Analysis reported that the U.S capital stock was $46.3
trillion at the end of 2010, $46.6 trillion at the end of 2011, and $47.0 trillion at the end of 2012 Depreciation in 2011 was $2.4 trillion, and gross investment during
2012 was $2.8 trillion (all in 2009 dollars)
13 Calculate U.S net investment and gross investment during 2011
Net investment equals the change in the capital stock In 2011, U.S net
investment was $46.6 trillion $46.3 trillion, which is $0.3 trillion Gross
investment equals net investment plus depreciation In 2011, U.S gross
investment was $0.3 trillion + $2.4 trillion, which is $2.7 trillion
14 Calculate U.S depreciation and net investment during 2012
Net investment equals the change in the capital stock In 2012, U.S net
investment was $47.0 trillion $46.6 trillion, which is $0.4 trillion Depreciation
equals gross investment minus net investment In 2012, U.S depreciation was $2.8 trillion $0.4 trillion, which is $2.4 trillion
15 Annie runs a fitness center On December 31, 2014, she bought an existing
business with exercise equipment and a building worth $300,000 During
2015, business improved and she bought some new equipment for $50,000
At the end of 2015, her equipment and buildings were worth $325,000
Calculate Annie’s gross investment, depreciation, and net investment during 2015
Annie’s net investment during 2015 is $25,000 because that is the change in her
capital stock Annie’s gross investment is $50,000 because that is her total
purchase of capital equipment in 2015 Annie’s depreciation during 2015 is
$25,000 because Annie’s net investment, $25,000, equals her gross investment,
$50,000, minus her depreciation
16 John is a researcher at a university, and after he paid taxes, his income and
interest from financial assets was $55,000 in 2013 At the beginning of 2013,
he owned $3,000 worth of financial assets At the end of 2013, John’s financial assets were worth $5,000
a How much did John save during 2013?
John’s wealth increased by $2,000 in 2013 So his saving in 2013 is $2,000,
assuming there are no capital gains or losses on his stocks and bonds
b How much did John spend on consumption goods and services?
John’s income after taxes was $55,000 His consumption equals his income minus his saving, which is $55,000 $2,000 = $53,000
F I N A N C E , S AV I N G , A N D I N V E S T M E N T 9 1
Trang 817 In a speech at the CFA Society of Nebraska in February 2007, William Poole (former Chairman of the St Louis Federal Reserve Bank) said: Over most of the post-World War II period, the personal saving rate averaged about 6 percent, with some higher rates from the mid-1970s to mid-1980s The
negative trend in the saving rate started in the mid-1990s, about the same time the stock market boom started Thus it is hard to dismiss the hypothesis that the decline in the measured saving rate in the late 1990s reflected the response of consumption to large capital gains from corporate equity [stock] Evidence from panel data of households also supports the conclusion that the decline in the personal saving rate since 1984 is largely a consequence of capital gains on corporate equities
a Is the purchase of corporate equities part of household consumption or saving? Explain your answer
The purchase of corporate equities, that is, shares of corporate stock, is part of household saving Consumption refers to the purchase of goods and services that are then consumed, but corporate equities are not consumable goods or services
b Equities reap a capital gain in the same way that houses reap a capital gain Does this mean that the purchase of equities is investment? If not, explain why it is not
The purchase of equities is not an investment because investment refers to the purchase of physical capital Equities are not physical capital and so they are not investment
18 Draw a graph to illustrate the effect of
an increase in the demand for loanable
funds and an even larger increase in
the supply of loanable funds on the
real interest rate and the equilibrium
quantity of loanable funds
Figure 7.2 shows the effect of an
increase in the demand for loanable
funds and an even larger increase in the
supply of loanable funds The demand
curve for loanable funds shifts rightward
from DLF0 to DLF1, and the supply curve
of loanable funds shifts rightward from
SLF0 to SLF1 The increase in supply is
larger than the increase in demand, so
the real interest rate falls (from 6
percent to 5 percent in the figure) and
the quantity of loanable funds increases
(from $2.3 trillion to $2.7 trillion in the figure)
9 2 C H A P T E R 7
Trang 919 Draw a graph to illustrate how an
increase in the supply of loanable funds
and a decrease in the demand for
loanable funds can lower the real
interest rate and leave the equilibrium
quantity of loanable funds unchanged
Figure 7.3 shows the effect of an increase
in the supply of loanable funds and a
decrease in the demand for loanable
funds The supply of loanable funds curve
shifts rightward from SLF0 to SLF1, and
the demand for loanable funds curve
shifts leftward from DLF0 to DLF1 The
magnitude of the increase in supply is
equal to the magnitude of the decrease in
demand, so the real interest rate falls
(from 7 percent to 4 percent in the figure)
and the quantity of loanable funds does
not change (staying at $2.5 trillion in the
figure)
Use the following information to work Problems 20 and 21
In 2012, the Lee family had disposable
income of $80,000, wealth of $140,000, and
an expected future income of $80,000 a year
At a real interest rate of 4 percent a year, the
Lee family saves $15,000 a year; at a real
interest rate of 6 percent a year, they save
$20,000 a year; and at a real interest rate of
8 percent, they save $25,000 a year
20 Draw a graph of the Lee family’s supply
of loanable funds curve
Figure 7.4 shows the Lee family’s supply
of loanable funds curve
21 In 2013, suppose that the stock market
crashes and the default risk increases
Explain how this increase in default risk
influences the Lee family’s supply of
loanable funds curve
If default risk increases the Lee family will decrease its saving As a result, the Lee family’s supply of loanable funds decreases and its supply of loanable funds curve shifts leftward
F I N A N C E , S AV I N G , A N D I N V E S T M E N T 9 3
Trang 1022 Gunvor Becomes Major Winner in Rosneft Oil Tender
Trading house Gunvor is among the winners of a large Rosneft tender Gunvor would lift up to 400,000 tonnes of Russian Urals crude per month from the Baltic Sea port of Primorsk in April-September
Source: Reuters, March 17, 2015
On a graph, show the effect of Gunvor going to the loanable funds market to finance its operation Explain the effect
on the real interest rate, private saving,
and investment
Gunvor’s demand for financial capital to
fund its operation increases the demand
for loanable funds As Figure 7.5
illustrates, the demand curve for loanable
funds shifts rightward from DLF0 to DLF1
The real interest rate rises Private saving
and investment both increase
23 The table sets out the data for
an economy when the
government’s budget is
balanced
a Calculate the equilibrium real
interest rate, investment, and
private saving
The equilibrium real interest rate
is 4 percent per year Equilibrium
investment equals the quantity
of loanable funds demanded,
$6.0 trillion Equilibrium saving
equals the quantity of loanable
funds supplied, (also) $6.0 trillion
b If planned saving decreases by $1 trillion at each real interest rate, explain the change in the real interest rate and investment
If planned saving increases by $1 trillion, the supply of loanable funds increases Consequently the equilibrium real interest falls and the equilibrium quantity of investment increases In the table, the equilibrium real interest rate falls to 3.5 percent and equilibrium investment increases to $6.5 trillion
c If planned investment decreases by $1 trillion at each real interest rate, explain the change in saving and the real interest rate
If planned investment decreases by $1 trillion, the demand for loanable funds decreases Consequently the equilibrium real interest falls and the equilibrium quantity of saving decreases In the table, the equilibrium real interest rate falls to 3.5 percent and equilibrium saving decreases to $5.5 trillion
Real interest rate
Loanable funds demanded
Loanable funds supplied (percent per
9 4 C H A P T E R 7