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Chapter 4: Q31 (page 106)

Table 4.6 shows the amount of savings and borrowing in a market for loans to purchase homes, measured in millions of dollars, at various interest rates. What is the equilibrium interest rate and quantity in the capital financial market? How can you tell? Now, imagine that because of a shift in the perceptions of foreign investors, the supply curve shifts so that there will be $10 million less supplied at every interest rate. Calculate the new equilibrium interest rate and quantity, and explain why the direction of the interest rate shift makes intuitive sense.

Short Answer

Expert verified

Equilibrium interest rate is at 7%, equilibrium quantity of funds = 140.

Decrease in supply will imply that new equilibrium interest rate = 8%, equilibrium funds = 135

Step by step solution

01

Equilibrium Basics 

Financial market is at equilibrium where demand for funds = supply of funds, & THE curves intersect. Demand & supply intersection, equalisation give corresponding equilibrium interest rate & equilibrium funds quantity.

02

Numerical Solution 

Here, demand and supply are equal at 7% interest rate, where funds' quantity demanded & supplied = 140.

So, equilibrium interest rate is at 7%, equilibrium quantity of funds = 140.

03

Supply Shift - Concept & Numerical 

A decrease in supply of funds, due to factors other than interest rate - shifts the supply curve leftwards.

New equilibrium is calculated by equalisation of new supply & demand.

Interest RateSupply (New decreased)Demand
5%130 - 10 = 120170
6%135 - 10 = 125150
7%140 - 10 = 130140
8%145 - 10 = 135 135
9%150 - 10 = 140125
10%155 - 10 = 145110

New supply & demand are equal when equilibrium funds demanded & supplied = 135 & equilibrium interest rate = 8%

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Most popular questions from this chapter

Which of the following changes in the financial market will lead to an increase in the quantity of loans made and received:

a. rise in demand

b. a fall in demand

c. a rise in supply

d. a fall in supply

Identify the most accurate statement. A price floor will have the largest effect if it is set:

a. substantially above the equilibrium price

b. slightly above the equilibrium price

c. slightly below the equilibrium price

d. substantially below the equilibrium price

During a discussion several years ago on building a pipeline to Alaska to carry natural gas, the U.S. Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would flow through the pipeline. The thinking behind the bill was that if private firms had a guaranteed price for their natural gas, they would be more willing to drill for gas and to pay to build the pipeline.

a. Using the demand and supply framework, predict the effects of this price floor on the price, quantity demanded, and quantity supplied.

b. With the enactment of this price floor for natural gas, what are some of the likely unintended consequences in the market?

c. Suggest some policies other than the price floor that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska.

Under what circumstances would a minimum wage be a nonbinding price floor? Under what circumstances would a living wage be a binding price floor?

During a discussion several years ago on building a pipeline to Alaska to carry natural gas, the U.S. Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would flow through the pipeline. The thinking behind the bill was that if private firms had a guaranteed price for their natural gas, they would be more willing to drill for gas and to pay to build the pipeline.

a. Using the demand and supply framework, predict the effects of this price floor on the price, quantity demanded, and quantity supplied.

b. With the enactment of this price floor for natural gas, what are some of the likely unintended consequences in the market?

c. Suggest some policies other than the price floor that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska.
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