Economics » Labour and Financial Markets » Demand and Supply in Financial Markets

Key Concepts and Summary

Key Concepts and Summary

In the demand and supply analysis of financial markets, the “price” is the rate of return or the interest rate received. The quantity is measured by the money that flows from those who supply financial capital to those who demand it.

Two factors can shift the supply of financial capital to a certain investment: if people want to alter their existing levels of consumption, and if the riskiness or return on one investment changes relative to other investments. Factors that can shift demand for capital include business confidence and consumer confidence in the future—since financial investments received in the present are typically repaid in the future.

Glossary

interest rate

the “price” of borrowing in the financial market; a rate of return on an investment

usury laws

laws that impose an upper limit on the interest rate that lenders can charge

Review Questions

  1. How is equilibrium defined in financial markets?
  2. What would be a sign of a shortage in financial markets?
  3. Would usury laws help or hinder resolution of a shortage in financial markets?

Critical Thinking Questions

  1. Suppose the U.S. economy began to grow more rapidly than other countries in the world. What would be the likely impact on U.S. financial markets as part of the global economy?
  2. If the government imposed a federal interest rate ceiling of 20% on all loans, who would gain and who would lose?

Problems

1. Predict how each of the following economic changes will affect the equilibrium price and quantity in the financial market for home loans. Sketch a demand and supply diagram to support your answers.

  1. The number of people at the most common ages for home-buying increases.
  2. People gain confidence that the economy is growing and that their jobs are secure.
  3. Banks that have made home loans find that a larger number of people than they expected are not repaying those loans.
  4. Because of a threat of a war, people become uncertain about their economic future.
  5. The overall level of saving in the economy diminishes.
  6. The federal government changes its bank regulations in a way that makes it cheaper and easier for banks to make home loans.

2. The table below shows the amount of savings and borrowing in a market for loans to purchase homes, measured in millions of dollars, at various interest rates. What is the equilibrium interest rate and quantity in the capital financial market? How can you tell? Now, imagine that because of a shift in the perceptions of foreign investors, the supply curve shifts so that there will be $10 million less supplied at every interest rate. Calculate the new equilibrium interest rate and quantity, and explain why the direction of the interest rate shift makes intuitive sense.

Interest RateQsQd
5%130170
6%135150
7%140140
8%145135
9%150125
10%155110

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