Macroeconomics

‭Let's‬‭rearrange‬‭the‬‭Fisher‬‭Equation‬‭to‬‭calculate‬‭the‬‭real‬‭interest‬‭rate‬‭when‬‭given‬‭the‬‭nominal‬‭interest‬‭rate‬ ‭and expected inflation rate:‬

‭●‬ ‭Nominal interest rate (i): 5%‬ ‭●‬ ‭Expected inflation rate (π): 2%‬

‭Real interest rate (r) = nominal interest rate (i)‬ ‭−‬ ‭expected inflation rate (π)‬

‭Substituting the values:‬

‭r = 5% − 2% = 3%‬

‭So,‬ ‭in‬ ‭this‬ ‭example,‬ ‭if‬ ‭there‬ ‭is‬‭a‬‭nominal‬‭interest‬‭rate‬‭of‬‭5%‬‭on‬‭an‬‭investment‬‭or‬‭loan,‬‭and‬‭the‬‭inflation‬ ‭rate‬ ‭is‬ ‭expected‬ ‭to‬ ‭be‬ ‭2%,‬ ‭the‬ ‭real‬ ‭interest‬ ‭rate‬ ‭(adjusted‬ ‭for‬ ‭inflation)‬ ‭would‬ ‭be‬ ‭3%.‬ ‭This‬ ‭means‬‭that‬ ‭purchasing power would increase by approximately 3% after accounting for the effects of inflation.‬ ‭I. Loanable Funds Market‬ ‭The‬ ‭loanable‬ ‭funds‬ ‭market‬ ‭is‬ ‭a‬ ‭hypothetical‬ ‭fnancial‬ ‭market‬ ‭that‬ ‭illustrates‬ ‭the‬ ‭allocation‬ ‭of‬ ‭funds‬ ‭from‬‭savers‬‭(loan‬‭suppliers)‬‭to‬‭borrowers‬ ‭with‬‭investment‬‭projects‬‭(loan‬‭demanders).‬‭In‬‭this‬‭market,‬ ‭the‬ ‭interaction‬ ‭between‬ ‭those‬ ‭who‬ ‭supply‬ ‭and‬‭demand‬‭funds‬‭often‬‭occurs‬‭indirectly‬‭through‬‭fnancial‬ ‭institutions,‬ ‭typically‬‭banks.‬‭Banks‬‭pay‬‭interest‬‭to‬‭savers‬‭with‬‭savings‬‭accounts‬‭and‬‭utilize‬‭these‬‭funds‬ ‭to provide loans to borrowers, charging them interest to make profts.‬ ‭In‬ ‭the‬ ‭loanable‬ ‭funds‬ ‭market,‬ ‭the‬ ‭interaction‬ ‭of‬ ‭those‬ ‭who‬ ‭demand‬ ‭loans‬ ‭and‬ ‭those‬ ‭who‬‭supply‬ ‭them‬ ‭determines‬ ‭the‬ ‭quantity‬ ‭of‬ ‭loanable‬ ‭funds‬ ‭(Q‬ ‭LF‬ ‭)‬‭and‬‭the‬‭real‬‭interest‬‭rate‬‭(r.i.r)‬ ‭.‬‭This‬‭market‬ ‭determines‬ ‭the‬ ‭real‬ ‭instead‬ ‭of‬ ‭the‬ ‭nominal‬ ‭interest‬ ‭rate‬ ‭because‬ ‭investors’‬ ‭decisions‬ ‭are‬ ‭highly‬ ‭influenced‬‭by‬‭the‬‭change‬‭in‬‭the‬‭value‬‭of‬‭money‬‭over‬‭time‬‭(i.e.,‬‭the‬‭time‬‭value‬‭of‬‭money)‬‭as‬‭explained‬‭in‬ ‭the previous section.‬ ‭The Loanable Funds Market Graph‬ ‭Like‬‭all‬‭other‬‭markets‬‭examined‬‭so‬‭far,‬ ‭equilibrium‬‭in‬‭the‬‭loanable‬‭funds‬‭market‬‭is‬‭determined‬‭by‬‭the‬

‭intersection of the demand (D‬ ‭LF‬ ‭) and supply (S‬ ‭LF‬ ‭)‬‭of loanable funds‬ ‭.‬ ‭The following components make up the‬ ‭loanable funds‬‭market graph‬ ‭:‬ ‭ ➔ ‬ ‭Quantity of loanable funds on the horizontal axis‬ ‭ ➔ ‬ ‭Real interest rate on the vertical axis‬

‭ ➔ ‬ ‭A‬ ‭downward-sloping‬ ‭demand‬ ‭curve‬ ‭of‬ ‭loanable‬ ‭funds‬‭(D‬ ‭LF‬ ‭)‬ ‭.‬‭This‬‭curve‬‭represents‬‭the‬ ‭total‬ ‭amount‬ ‭of‬ ‭funds‬ ‭or‬ ‭loans‬ ‭that‬ ‭frms‬ ‭and‬ ‭households‬ ‭are‬ ‭willing‬ ‭and‬ ‭able‬ ‭to‬ ‭borrow‬ ‭.‬ ‭The‬ ‭negative‬ ‭slope‬ ‭of‬ ‭the‬ ‭curve‬ ‭indicates‬ ‭an‬ ‭inverse‬ ‭relationship‬ ‭between‬‭the‬‭real‬‭interest‬‭rate‬ ‭and‬‭the‬‭quantity‬‭demanded‬‭of‬‭loanable‬‭funds‬ ‭:‬‭As‬‭the‬‭real‬‭interest‬‭rate‬‭increases,‬‭the‬‭cost‬‭of‬ ‭borrowing increases, hence reducing the quantity demanded of loanable funds, and vice versa.‬

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