1. 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.

2. Loanable Funds Theory Extending the model Financial institutions Changes in supply Household thrift Changes in demand Rate of return on investment Other participants LO2 14-2

3. 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

4. Loanable Funds Theory Quantity of Loanable Funds Interest Rate (Percent) 0 D S i = 8% F0F0 The equilibrium interest rate LO2 14-4

5. 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

6. Time Value of Money Beginning ValueComputationTotal InterestEnd 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

7. Time-Value of Money LO3 (1)(2)(3)(4) Beginning Period ValueComputationTotal InterestEnd 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

8. 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

10. 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

11. 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

16. Global Perspective LO3 14-16