Rather when interest rates are high, businesses will finance investments with internally generated funds i. The more restrictive the conditions on borrowed funds, the less businesses borrow at any interest rate. Further, the greater the number of profitable projects available to businesses, or the better the overall economic conditions, the greater the demand for loanable funds. Governments also borrow heavily in financial markets. State and local governments often issue debt to finance temporary imbalances between operating revenues e.
Higher interest rates cause state and local governments to postpone such capital expenditures. Finally, foreign participants might also borrow in U. Foreign borrowers look for the cheapest source of funds globally. Most foreign borrowing in U. In addition to interest costs, foreign borrowers consider nonprice terms on loanable funds as well as economic conditions in the home country.
Factors that affect the supply of funds include total wealth risk of the financial security, future spending needs, monetary policy objectives, and foreign economic conditions. As the total wealth of financial market participants households, business, etc. Accordingly, at every interest rate the supply of loanable funds increases, or the supply curve shifts down and to the right.
The shift in the supply curve creates a disequilibrium in this financial market. As competitive forces adjust, and holding all other factors constant, the increase in the supply of funds due to an increase in the total wealth of market participants results in a decrease in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded.
Conversely, as the total wealth of financial market participants decreases the absolute dollar value available for investment purposes decreases.
Accordingly, at every interest rate the supply of loanable funds decreases, or the supply curve shifts up and to the left. The shift in the supply curve again creates a disequilibrium in this financial market.
As competitive forces adjust, and holding all other factors constant, the decrease in the supply of funds due to a decrease in the total wealth of market participants results in an increase in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded. As the risk of a financial security increases, it becomes less attractive to supplier of funds. Conversely, as the risk of a financial security decreases, it becomes more attractive to supplier of funds.
At every interest rate the supply of loanable funds increases, or the supply curve shifts down and to the right. As competitive forces adjust, and holding all other factors constant, the increase in the supply of funds due to a decrease in the risk of the financial security results in a decrease in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded.
Near-term Spending Needs. When financial market participants have few near-term spending needs, the absolute dollar value of funds available to invest increases.
The financial market, holding all other factors constant, reacts to this increased supply of funds by decreasing the equilibrium interest rate, and increasing the equilibrium quantity of funds traded. Conversely, when financial market participants have near-term spending needs, the absolute dollar value of funds available to invest decreases.
At every interest rate the supply of loanable funds decreases, or the supply curve shifts up and to the left. The shift in the supply curve creates a disequilibrium in this financial market that, when corrected results in an increase in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.
Monetary Expansion. One method used by the Federal Reserve to implement monetary. When monetary policy objectives are to enhance growth in the economy, the Federal Reserve increases the supply of funds available in the financial markets. At every interest rate the supply of loanable funds increases, the supply curve shifts down and to the right, and the equilibrium interest rate falls, while the equilibrium quantity of funds traded increases.
Conversely, when monetary policy objectives are to contract economic growth, the Federal Reserve decreases the supply of funds available in the financial markets. At every interest rate the supply of loanable funds decreases, the supply curve shifts up and to the left, and the equilibrium interest rate rises, while the equilibrium quantity of funds traded decreases.
Economic Conditions. Finally, as economic conditions improve in a country relative to other countries, the flow of funds to that country increases. The inflow of foreign funds to U. Accordingly, the equilibrium interest rate falls, and the equilibrium quantity of funds traded increases. Factors that affect the demand for funds utility derived from the asset purchased with borrowed funds, restrictiveness of nonprice conditions of borrowing, domestic economic conditions, and foreign economic conditions.
As the utility derived from an asset purchased with borrowed funds increases the willingness of market participants households, business, etc.
Accordingly, at every interest rate the demand for loanable funds increases, or the demand curve shifts up and to the right. The shift in the demand curve creates a disequilibrium in this financial market. As competitive forces adjust, and holding all other factors constant, the increase in the demand for funds due to an increase in the utility from the purchased asset results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded.
Conversely, as the utility derived from an asset purchased with borrowed funds decreases the willingness of market participants households, business, etc. Accordingly, at every interest rate the demand of loanable funds decreases, or the demand curve shifts down and to the left. The shift in the demand curve again creates a disequilibrium in this financial market.
As competitive forces adjust, and holding all other factors constant, the decrease in the demand for funds due to a decrease in the utility from the purchased asset results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.
Restrictiveness on Nonprice Conditions on Borrowed Funds. As the nonprice restrictions put on borrowers as a condition of borrowing increase the willingness of market participants to borrow decreases and the absolute dollar value borrowed decreases. The shift in the demand curve again creates. As competitive forces adjust, and holding all other factors constant, the decrease in the demand for funds due to an increase in the restrictive conditions on the borrowed funds results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.
Conversely, as the nonprice restrictions put on borrowers as a condition of borrowing decrease market participants willingness to borrow increases and the absolute dollar value borrowed increases. The shift in the demand curve results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded.
When the domestic economy is experiencing a period of growth, market participants are willing to borrow more heavily. Accordingly, at every interest rate the demand of loanable funds increases, or the demand curve shifts up and to the right.
As competitive forces adjust, and holding all other factors constant, the increase in the demand for funds due to economic growth results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded. Conversely, when economic growth is stagnant market participants reduce their borrowings increases. Accordingly, at every interest rate the demand for loanable funds decreases, or the demand curve shifts down and to the left.
The shift in the demand curve results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded. This chapter allows the instructor to branch out to various choices of later chapters, thus allowing different degrees of coverage of financial markets and institutions. The most important point to transmit to the student is that financial markets and financial intermediaries are crucial to a well-functioning economy because they channel funds from those who do not have a productive use for them to those who do.
No matter how much class time is devoted to this chapter, we have found that it is a good reference chapter for students. You might want to tell them that if in later chapters they do not recall what some financial instrument is or who regulates whom, they can refer back to this chapter, especially to the summary tables. The chapter introduces Global boxes, which are sprinkled throughout the text, to get students to recognize the growing importance of the global economy.
The Global box in this chapter gets students to think about how the financial system is different across countries. Learning Objectives By the end of this chapter, you will understand 1. The structure of financial markets — Direct and indirect finance — International dimensions of financial markets 2.
Various types of financial market instruments 3. Various types of financial intermediaries — How transaction costs, risk sharing, information matter 4. Improves Risk Sharing — Asset transformation — Diversification 3.
Increase information available to investors — Reduce adverse selection and moral hazard problems — Increase efficiency of financial markets 2.
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