• The Federal Reserve controls the amount of bank activity • and thus influences a wide variety of

interest rates. • The government also has an impact on the

lending process • by granting special tax treatment for

different types of interest.

Loanable Funds Theory

• Extending the model• Financial institutions• Changes in supply

•Household thrift• Changes in demand

•Rate of return on investment

• Other participantsLO2 14-2

Supply Of Loanable Funds• In theory, supply and demand

applies• Supply in many forms

• Bank loans• Bonds• Stocks

• Economists disagree how much $ is actually available to loan • Many variables

Loanable Funds Theory

Quantity of Loanable Funds

Inte

rest

Rat

e (P

erce

nt)

0

D

S

i =8%

F0

The equilibrium interest rate

LO2 14-4

Time-Value of Money

• Money is more valuable the sooner it is obtained•Ability to earn interest•Compound interest

• Future value• Present value

LO3 14-5

Time Value of Money• Beginning Value Computation Total Interest End Value

• $1,000 year 1 $1,000 X 1.10 = $1,100 $1,000$1,100

• $1,100 year 2

• $1,210 year 3

LO4 14-6

Time-Value of Money

LO3

(1) (2) (3) (4)Beginning

Period Value Computation Total Interest End Period Value

$1000 (Year 1) $1000 X 1.10 = $1100 $100 $1100 (=$1000 + $100)

$1100 (Year 2) $1100 X 1.10 = $1210 $210 (=$100 +$110) $1210(=$1000 + $210)

$1210 (Year 3) $1210 x 1.10 = $1331$331 (= $100 + $110+

$121) $1331(=$1000 + $331)

14-7

Time Value of Money• Works in the other way• What is an anticipated

$1,000,000 in 2054 worth today?

• Go to • Free On Line Calculator Use

• Future Value of Money

LO3 14-8

The Price of Credit• Effective interest rates• Discounting a loan• Repaying a loan in installments• Effects of compounding• Truth in Lending Act 1968• Truth in Savings Act 1991• Fees and teaser rates• Let the borrower beware

LO5 14-10

Role of Interest Rates• Relationship to:

• Total output• Allocation of capital• R&D spending

• Nominal and real rates• Application: Usury Laws

• Nonmarket rationing• Gainers and losers• Inefficiency

LO3 14-11

Global Perspective

LO3 14-16