Transcript How to Graph Any Market A recipe in # steps

Loanable Funds market
Framework
• This framework is particularly useful for predicting interest rate
changes due to events in the country or the world .
The analysis is conducted in terms of the price of money–
interest rates– directly. No extra step is needed to relate
the price of bonds (inversely) to the interest rate.
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Step 2: What is the
PRICE of the thing?
interest rate
Step 3: Who DEMANDS it? borrowers
LIST all the factors that affect demand:
expected income, expected inflation, gov’t
deficit...
they’d want less
Step 4: From this initial i&Q, if
the interest rate increased, would Note thatlabel
DLF by
it borrowers = SB
borrowers want more or less?...
5. DLF by borrowers
Step 5: connect those two points with
the DEMAND curve
QLF
Step 1: What is the thing? loanable funds
Draw and LABEL the axis
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Step 6: Who supplies it? savers
i
they’d save more
List factors that affect supply: wealth,
relative expected returns, relative risk,
relative liquidity, expected inflation...
LABEL IT:
Step 8. SLF by savers
Note that SLF by savers = DBONDS
Step 8: draw the supply curve
Step 7: from an initial i,Q; if i increased,
would savers provide less, or more...?
DLF by borrowers (=SBONDS)
QLF
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i
SLF by savers
io
Step 9: identify the initial equilibrium
interest rate (and quantity)
DLF by borrowers
QLF
Qo
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Step 10. How does the event affect
the factors of demand and supply?
Example Event:
What will happen to interest rates if people expect inflation to rise?
DLF = f ( i; eGDP, gov’t deficit, e ) = SBONDS
DEMAND:if borrowers expect inflation to rise (later), they would rather
buy more stuff now (to expand capacity, or whatever) so they would
BORROW MORE NOW. DLF increases (= SBONDS increases).
SLF = f ( i; W, eRETB/eREToth, B/oth, lB/loth, e ) = DBONDS
SUPPLY: if savers expect inflation to rise (later), they would rather buy
more stuff now, so they would SAVE LESS NOW. SLF decreases (=DBONDS
decreases).
Now illustrate these effects on your graph,
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Step 12. illustrate change (if any) in Supply
i
i
SLF by savers
SLF decreases
1
io
DLF increases
Step 13. identify
the new
equilibrium i
DLF by borrowers
Step 11. illustrate change (if any) in Demand
QLF
Qo
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Step 14. SUMMARIZE: If people expect inflation to rise, savers will supply fewer
loans, because they would rather buy stuff now while prices are low. Borrowers will
demand more loans so they can expand capacity and sell more stuff later when prices
are higher. Interest rates will rise.
i
i
SLF by savers
1
io
DLF by borrowers
QLF
note: the change in the equilibrium quantity of loanable
funds is not important in the analysis of interest rates.
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