GROUP 2
THE
INTEREST RATES
- the market price of earlier
availability
- price of loanable funds
- the premium paid by borrowers in
order to acquire goods sooner and
pay for them later.
- the reward for lenders; a payment
for supplying others with current
purchasing power.
HOW INTEREST RATES ARE DETERMINED
 Interest rates are determined by
the demand for and supply of
loanable funds.
 The demand of investors for
loanable funds stems from the
productivity of capital.
 Interest rates bring the quantity of
funds demanded into balance with
the quantity supplied.
 At the equilibrium interest rate, the
quantity of funds borrowers
demand for investment and
consumption will equal the quantity
of funds lenders save.
KEYNESIAN THEORY: The Rate of interest is
determined as a price in two markets:
1. Investment Funds- interest rates
balances the demand for funds and the
supply of funds.
2. Liquid Assets- borrowers compensate
lenders for giving up liquidity.
THE NOMINAL OR MONEY RATE VS.
REAL RATE OF INTEREST
 High rates of inflation will lead to a
high money rate.
THE THREE COMPONENTS OF MONEY
INTEREST:
1. Pure interest- real price one must
pay for earlier availability.
2. Inflationary Premium - reflects the
expectation that the loan will be
repaid with pesos of less purchasing
power as a result of inflation.
3. Risk-premium - reflects the
probability of default. (possibility
that the borrower may be unable to
repay the loan)
THE IMPACT OF CHANGING INTEREST
RATES
Short Term Interest Rates- relative for
loans with relatively short length for
repayment
Long Term Interest Rates- relevant for
long term corporate borrowing and 10-
20-30 year fixed rate mortgages.
HIGH INTEREST RATES
- Make loans less affordable
- Encourages saving rather than
spending
- Demand for goods and services
decrease
LOW INTEREST RATES
- Cheaper to take out loans
- Causes an increase in spending
- Demand for products and services
rise.