Use the loanable funds theory to explain questions a, b and c.
a. If the housing market improves, what should happen to interest rates? Why?
b. A decrease in employment will most likely cause interest rates to _ _ _ _ _ _ . Why?
c. How would the reduction in Japan's rates impact interest rates in the United States?
Loanable Funds :
The loanable fund's theory is related to the interest rates in the market. According to this theory, the interest rates in the market are set by the supply and demand forces of loanable funds. It includes all forms of borrowings, such as bonds, loans, and others.
Answer and Explanation:
a) With the improvement in the housing market, the wealth of the households will increase. This increased wealth increases the spending of people. As household increases their spending, it induces them to increase their borrowing as well, which will eventually increase the loanable funds demand, increasing the interest rates in the market.
b) A decrease in employment will result in a fall in interest rates. It is because; a fall in employment will have adverse impacts on the incomes of the households. This fall in income will lead to a fall in the repayment ability of the people, decreasing the demand for loanable funds, decreasing the interest rates.
c) If there is a reduction in Japan's rates, it will result in a decrease in investment incentives for investors. So, they will move their investments to the United States instead of Japan, as the interest rate will be relatively lower in Japan. The increase in capital of the United States will eventually lead to a rise in the supply of loanable funds in the US market. This increase in supply will lead to a fall in the interest rates of the United States.
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from Introduction to Business: Homework Help ResourceChapter 25 / Lesson 29