How to Graphically Analyze Any Market This recipe can be used to analyze any market: to predict the effect of some change in the country or the world on the prices and quantities transacted of: bonds stocks currencies pollution permits,... anything commodities GO to next A recipe in 15 steps loanable funds

S tep 1: What is the thing? Bonds Draw and LABEL the axis Q Bonds S tep 2: What is the PRICE of the thing? Draw and label the axis P B S tep 3: Who DEMANDS it? savers LIST all the factors that affect demand: wealth, relative returns, relative risk, relative liquidity, expected inflation S tep 4: From this initial P&Q, if P B increased, would Bond demanders want more or less?... they’d want less S tep 5: connect those two points with the DEMAND curve label it 5. D BONDS by savers go to next

Q Bonds PBPB List factors that affect supply: expected income, gov’t debt, expected inflation D BONDS by savers go to next Step 6: Who supplies it? borrowers Step 7: from an initial P,Q; if P B increased, would suppliers sell less, or more...? they’d sell more Step 9: draw the supply curve LABEL IT: Step 8. S BONDS by borrowers

Q Bonds PBPB D BONDS by savers go to next S BONDS by borrowers Step 10: identify the initial equilibrium price (and quantity) PoPo QoQo

Step 11. 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? DEMAND: if savers expect inflation to rise (later), they would rather buy more stuff now, so they would SAVE LESS NOW. D BONDS decreases. SUPPLY: 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. S BONDS increases. Now illustrate these effects on your graph, go to next D BONDS = f ( P B ; W, e RET B / e RET oth,  B /  oth, l B /l oth, e  ) S BONDS = f ( P B ; e GDP, gov’t deficit, e  )

Q Bonds PBPB D BONDS by savers go to next S BONDS by borrowers PoPo QoQo Step 12. illustrate change (if any) in Demand D BONDS decreases Step 13. illustrate change (if any) in Supply S BONDS increases Step 14. identify the new equilibrium P P1P1

Q Bonds PBPB D BONDS by savers start over S BONDS by borrowers PoPo D BONDS decreases S BONDS increases P1P1 Step 15. SUMMARIZE: If people expect inflation to rise, savers will demand fewer bonds now, because they would rather buy stuff now while prices are low. Borrowers will supply more bonds so they can expand capacity and sell more stuff later when prices are higher. Bond prices will fall, so interest rates will rise. back to Kilkenny’s 353 web page note: the change in the equilibrium quantity of bonds is not important for the analysis of interest rates.