If nominal interest rate is 8% and inflation is 3%, what is the real interest rate?
Real interest rate = 8% - 3% = 5%
How does unexpected high inflation affect borrowers?
Borrowers benefit as they repay loans with money that has less purchasing power than expected.
How does unexpected high inflation affect lenders?
Lenders are hurt because they receive repayments with less purchasing power than they anticipated.
If actual inflation is lower than expected, who benefits?
Lenders benefit because the real interest rate is higher than anticipated.
How do economists use expected inflation rates?
To set nominal interest rates, factoring in what they think inflation will be in the future.
How does an increase in government borrowing affect interest rates?
Increases demand for loanable funds, potentially raising real interest rates.
Explain how consumer confidence affects the loanable funds market.
Increased consumer confidence can increase borrowing, shifting the demand curve for loanable funds to the right and potentially raising interest rates.
What happens to real interest rates when nominal interest rates remain constant but inflation increases?
Real interest rates decrease because the purchasing power of the returns diminishes.
If the nominal interest rate is 6% and the real interest rate is 2%, what is the inflation rate?
Inflation rate = 6% - 2% = 4%
How does a decrease in business investment impact the demand for loanable funds?
It decreases the demand, shifting the demand curve to the left and potentially lowering interest rates.
On a loanable funds market graph, show the effect of increased government borrowing.
The demand curve shifts right, increasing both the equilibrium interest rate and quantity of loanable funds.
On a loanable funds market graph, show the effect of increased consumer savings.
The supply curve shifts right, decreasing the equilibrium interest rate and increasing the quantity of loanable funds.
How does increased business investment affect the loanable funds market?
It shifts the demand curve for loanable funds to the right, increasing the equilibrium interest rate and quantity of loanable funds.
Illustrate the impact of decreased consumer confidence on the loanable funds market.
The demand curve shifts left, decreasing both the equilibrium interest rate and quantity of loanable funds.
How would a decrease in the supply of loanable funds affect the equilibrium?
The supply curve shifts left, increasing the equilibrium interest rate and decreasing the quantity of loanable funds.
What does the vertical axis represent in the market for loanable funds?
The real interest rate.
What does the horizontal axis represent in the market for loanable funds?
The quantity of loanable funds.
Explain how expected inflation is reflected in the loanable funds market.
Expected inflation influences both the supply and demand curves, affecting the equilibrium nominal interest rate.
Show the effect of a tax cut on savings on the loanable funds market graph.
The supply curve shifts right, leading to a lower equilibrium interest rate and a higher quantity of loanable funds.
How does a change in the risk associated with lending affect the supply of loanable funds?
Increased risk reduces the supply, shifting the supply curve left and increasing the equilibrium interest rate.
What is the nominal interest rate?
The stated interest rate before accounting for inflation.
What is the real interest rate?
The interest rate after adjusting for inflation; reflects the true return on investment or cost of borrowing.
Define inflation premium.
Compensation lenders require for the expected loss of purchasing power of money over time, included in the nominal interest rate.
What is the market for loanable funds?
The market where savers (suppliers of funds) and borrowers (demanders of funds) interact to determine the interest rate.
What is the formula for nominal interest rate?
Nominal Interest Rate = Real Interest Rate + Inflation
What is the formula for real interest rate?
Real Interest Rate = Nominal Interest Rate - Inflation
What is the significance of a negative real interest rate?
Inflation is higher than the nominal interest rate, eroding savings value and making borrowing cheaper.
Define expected inflation rate.
The rate of inflation that economists and lenders anticipate will occur in the future, used to set nominal interest rates.
What determines the equilibrium interest rate?
The interaction of supply and demand in the market for loanable funds, factoring in expected inflation.
What is the relationship between nominal and real interest rates?
The nominal interest rate includes the effect of inflation, while the real interest rate shows the true return after accounting for inflation.
