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Ec 140 February 27.docx

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Wilfrid Laurier University
Justin Smith

Ec 140 February 27, 2013 The Market for Loanable Funds Midterm for chapters 20 21 27 26 23 24  Business changes investment/ gov spending  How do they get money to do this?  Market coordinates lending and borrowing from three sectors  Households  Gov  Rest of the world Memorize the equation of (S-I)+(T-G)+(M-X)= 0 S = savings by house holds I= investments =private savings T= tax G= Government spending Gov saving M= import X= export Foreign sector saving Example: you want to purchase a Mercedes. You pay 50 000 for the vehicle. Perspective from Canada you are importing. Therefore you are saving 50 000 to your Canadian bank to trade for the car = foreign sector saving The equation means (S-I)+(T-G)+(M-X)= 0 -If some people borrow = some people save Private investment> Saving = borrowing money from gov or rest of the world Gov spending > tax = gov get money from citizens or foreigners Gov borrows money by creating bonds = give gov a sum of money, and the gov gives a piece of paper that details on how much interest they will give you within the time period -banks buy a lot of gov bonds = biggest customer for gov The Real interest rate -the nominal interest rate is the number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent -example you borrow money from cibc and you borrow 500 dollars and your nominal interest rate is 5 percent per year = 25 dollars paid to them -remember value of money falls as time goes by example 100 dollars today is not the same worth as 100 dollars in 10 years Charge interest on loan because 1. Risk if you don’t pay back 2. Value of money rise Real vs nominal - Real interest rate can be 0 - Nominal cannot be 0 Nominal – inflation rate = real interest rate Real interest rate = nominal interest rate adjusted to remove the effects of inflation on the buying power of money Market for Loanable Funds -market where loanable funds come together for borrowers and lender -demand and supply curve is in this Demand curve = relationship btw the real interest rate and quantity of loanable funds demanded -higher = fewer investment projects are worthwhile so fewer funds are borrowed -lower = borrowing costs, more worthwhile projects Low interest rate = more people borrowing money to invest therefore even unprofitable business would borrow High interest rate = less people borrowing money to invest therefore only the profitable business would borrow Higher amount of expected profit in borrowing = shift to right of demand curve Lower amount of expect profit in borrowing = shift to left of demand curve Supply curve = relationship btw the real interest rate and the quantity of loanable funds supplied Factors that will change the curve: 1. Disposable income (extra income means supply or loanable curve shits right) 2. Expected future income (more income tmw will incent you to consume today, therefore reduce saving today and supply shifts left) 3. Weal
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