Economics Credit and Banking Review

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Questions and Answers

What is the difference between nominal and real interest rates?

The nominal interest rate is the rate you pay on a loan. The real interest rate is the nominal interest rate adjusted for inflation.

Why does the credit demand curve slope downward?

A higher real interest rate reduces a borrowing firm's profit and hence its willingness to borrow.

What can cause a shift in the credit demand curve?

Changes in government policy, changes in perceived business opportunities for firms, and changes in household preferences or expectations.

Why does the credit supply curve slope upward?

A higher real interest rate discourages current consumption, and a higher real interest rate encourages more saving. Signup and view all the answers

What can cause a shift in the credit supply curve?

An elevated perception on the part of households that the future may hold many 'rainy days', an aging population that is ill-prepared for retirement, and a heightened desire on the part of firms to internally fund their future activities. Signup and view all the answers

What is the formula to find the real rate of interest?

Real interest rate = nominal interest rate - inflation rate Signup and view all the answers

Who benefits if the economy experiences an unexpectedly low rate of inflation?

Creditors (people or institutions that are owed money) Signup and view all the answers

Why do the inflation rate and the nominal interest rate tend to move together over the long run?

This synchronized movement indicates that credit market conditions have tended to be relatively stable over time. Signup and view all the answers

If pi denotes the rate of inflation and i denotes the nominal rate of interest, the amount a borrower repays in a year on a one-dollar loan is _ and the inflation-adjusted purchasing power of the originally borrowed dollar is _

1+i and 1+pi Signup and view all the answers

What is subtracted from the amount a borrower repays in a year on a one-dollar loan?

The inflation-adjusted purchasing power of the originally borrowed dollar. Signup and view all the answers

What can produce a movement along the credit demand curve?

A change in the real interest rate. Signup and view all the answers

What categories balance with assets?

Long-term investments, reserves, and cash equivalents. Signup and view all the answers

What categories balance with stockholders?

Long-term debt, demand deposits, stockholders equity, and short-term borrowing. Signup and view all the answers

What is the process of channeling funds from suppliers of financial capital to users called?

Financial intermediation. Signup and view all the answers

What are the two basic types of financial capital?

Credit and equity. Signup and view all the answers

Study Notes

Interest Rates

Nominal interest rates represent the stated rate on loans, while real interest rates adjust the nominal rate for inflation.
Real interest rate can be calculated using the formula: Real interest rate = Nominal interest rate - Inflation rate.

Credit Demand and Supply

The credit demand curve slopes downward due to higher real interest rates reducing profit for borrowing firms, thereby decreasing their willingness to borrow.
A shift in the credit demand curve can result from changes in government policy, business opportunity perceptions, or household expectations.
The credit supply curve slopes upward because elevated real interest rates discourage immediate consumption and encourage saving.
Shifts in the credit supply curve can emerge from perceptions of economic uncertainty, an aging population's retirement readiness, and firms’ desires to self-fund activities.

Inflation and Its Effects

Unexpectedly low inflation rates benefit creditors, who are owed money, as the purchasing power of repayments increases.
Inflation rates and nominal interest rates tend to move together in the long run, reflecting stable credit market conditions and a relatively stable real interest rate.

Borrowing Dynamics

When a borrower takes a one-dollar loan, the total repayment amount in a year is represented by (1 + i), where i is the nominal interest rate.
The inflation-adjusted purchasing power of the original dollar loan is represented by (1 + π), where π is the inflation rate.

Financial Intermediation

The process of channeling funds from suppliers to users of financial capital is termed financial intermediation.
Financial capital can be classified into two basic types: credit and equity.

Balance Sheet Components

Key asset categories balancing with liabilities include long-term investments, reserves, and cash equivalents.
Key liabilities and stockholder components include long-term debt, demand deposits, stockholder equity, and short-term borrowing.

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Description

This quiz focuses on key concepts from credit and banking, including the differences between nominal and real interest rates. It also covers the factors affecting the credit demand curve and shifts in economic parameters. Ideal for students reviewing their economics material.