ECON 104 Lecture Notes - Lecture 12: Loanable Funds, Real Interest Rate, Reservation Price

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raspberryswan494

26 Oct 2016

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Recall that an interest rate is simply just the cost of money. Hut how will the interest rate be determined. This is where the market for loanable funds comes into play. Market for loanable funds- the interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged. Everyone who wants to borrow has a reservation price because they are borrowing for a reason. As long as interest rate is lower than the expected return rate. This market of supply and demand will determine the interest rate at which firms will be able to borrow. For now, let"s assume no international borrowing. The demand side of the market consists of firms. Firms want funds to be able to make an investment in future production. A higher interest rate will lead to less quantity of loanable funds demanded as it will cost more to get the money.

Related Questions

Answer the following four questions related to the market for loanable funds.

1. What effect will an increase in the interest rate have on the quantity of loanable funds applied?

a. quantity supplied will increase

b. quantity supplied will decrease

c. Some lenders will offer more while others will offer less.

d. No change in quantity supplied

2. As the interest rate decreases, what happens to the quantity of loanable funds demanded?

a. Some borrowers will demand more and others will demand less

b. quantity demanded will increase

c. No change in quantity demanded

d. quantity demanded will decrease

3. Which of the following acts as a price in the market for loanable funds?

a. Interest rate

b. Capital

c. Demand

d. Supply

4. If the projected rate of return for a project is less than the interest rate for a loan that is necessary to complete the project, how will the borrowing business act?

a. The business will not take the loan

b. The business will take the loan

c. The business will demand more funds to cover the shortfall

d. Business will take the loan irrespective of the interest rate

orangecrab995

Three students have each saved $\$$1,000. Each has an investment opportunity in which he or she can invest up to $\$$2,000. Here are the rates of return on the students' investment projects:

Harry $\quad$ 5 percent

Ron $\quad$ 8 percent

Hermione $\quad$ 20 percent

a. If borrowing and lending are prohibited, so each student uses only personal savings to finance his or her own investment project, how much will each student have a year later when the project pays its return?

b. Now suppose their school opens up a market for loanable funds in which students can borrow and
lend among themselves at an interest rate $r$. What would determine whether a student would choose to be a borrower or lender in this market?

c. Among these three students, what would be the quantity of loanable funds supplied and quantity
demanded at an interest rate of 7 percent? At 10 percent?

d. At what interest rate would the loanable funds market among these three students be in equilibrium? At this interest rate, which student(s) would borrow and which student(s) would lend?

e. At the equilibrium interest rate, how much does each student have a year later after the investment projects pay their return and loans have been repaid? Compare your answers to those you gave in part (a). Who benefits from the existence of the loanable funds market$-$the borrowers or the lenders? Is anyone worse off?

silverwolf680

Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the student's investment projects:

Student	Return
Student	(Percent)
Yakov	4
Charles	7
Dina	15

Assume borrowing and lending are prohibited, so each student uses only personal savings to finance his or her own investment project.

Complete the following table with how much each student will have a year later when the project pays its return.

Student	Money a Year Later
Student	(Dollars)
Yakov	_________
Charles	_________
Dina	_________

Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate or.

If a studentâs expected rate of return is greater than r, he or she would choose to (lend, borrow).

Suppose the interest rate is 6 percent.

Among these three students, the quantity of loanable funds supplied would be $______, and quantity demanded would be $______.

Now suppose the interest rate is 12 percent.

Among these three students, the quantity of loanable funds supplied would be $______, and quantity demanded would be $______.

At an interest rate of ______%, the loanable funds market among these three students would be in equilibrium. At this interest rate, (Charles, Yakov, Yakov and Charles, Charles and Dina, Dina) would want to borrow, and (Charles, Yakov, Yakov and Charles, Charles and Dina, Dina) want to lend.

Suppose the interest rate is at the equilibrium rate.

Complete the following table with how much each student will have a year later after the investment projects pay their return and loans have been repaid.

Student	Money a Year Later
Student	(Dollars)
Yakov	_________
Charles	_________
Dina	_________

True or False: Only borrowers are made better off, and lenders are made worse off.

cyansheep662

ECON 104 Lecture Notes - Lecture 12: Loanable Funds, Real Interest Rate, Reservation Price

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