ECON 2H03 Lecture Notes - Lecture 8: Loanable Funds, Real Interest Rate, Demand Curve

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A simple supply-demand model of the financial system. One asset: loanable funds : demand for funds: investment, supply of funds: saving, price of finds: real interest rate. Comes from investment: firms borrow to finance spending on plant & equipment, new office buildings, etc. Depends negatively on r: the price of loanable funds (cost of borrowing) assuming no households. The supply of loanable funds comes from saving: households use their saving to make bank deposits, purchase bonds and other assets. These funds become available to firms to borrow and finance investment spending: the government may also contribute to saving if it does not spend all the tax revenue it receives. National saving (s) = private saving + public saving = y c g. If t = g, there is a balanced budget, public saving = 0. Fiscal policy is a change in g or t.

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