Understanding Demand and Supply in Finance

Dec 29, 2024

4.2 Demand and Supply in Financial Markets

Learning Objectives

  • Identify the demanders and suppliers in a financial market.
  • Explain how interest rates can affect supply and demand.
  • Analyze the economic effects of U.S. debt in terms of domestic financial markets.
  • Explain the role of price ceilings and usury laws in the U.S.

Overview

  • U.S. households, institutions, and businesses saved $1.3 trillion in 2015.
  • Savings are distributed to banks, invested in private companies, or loaned to government agencies.
  • Demand and supply model links suppliers of financial capital (savers) with demanders (borrowers).

Who Demands and Supplies in Financial Markets?

  • Suppliers: Individuals and businesses who save money, expecting a rate of return.
  • Demanders: Individuals or businesses who borrow money and are willing to pay a rate of return.
  • Interest rate is a common form of rate of return.

Credit Card Market Example

  • In 2021, almost 200 million Americans held credit cards.
  • Typical credit card interest rates: 12% to 18% per year.
  • In May 2021, Americans owed $807 billion on credit cards.
  • Equilibrium interest rate example: 15%, with $600 billion loaned and borrowed.

Equilibrium in Financial Markets

  • Equilibrium occurs where quantity demanded equals quantity supplied.
  • Above-equilibrium interest rates lead to surplus; below-equilibrium lead to shortages.

Shifts in Demand and Supply in Financial Markets

  • Decisions involve how much to save and how to distribute savings across investments.
  • Intertemporal Decision-Making: Choices about consumption now vs. future.
  • Changes in confidence or economic conditions can shift demand or supply curves.

Examples

  • Social Security may reduce personal savings, shifting supply left.
  • Economic confidence (e.g., tech boom) can shift demand right.

The United States as a Global Borrower

  • U.S. attracts significant foreign investment.
  • Concerns about U.S. public debt can reduce foreign investment, raising interest rates.

Price Ceilings in Financial Markets: Usury Laws

  • Political pressures may lead to interest rate caps on credit cards.
  • Price ceilings can cause credit shortages.
  • Usury laws set maximum interest rates but are often nonbinding if set high.

Key Graphs and Tables

  • Figure 4.5: Shows demand and supply curves for credit card borrowing.
  • Table 4.5: Illustrates quantity of financial capital demanded and supplied at different interest rates.
  • Figure 4.6 & 4.7: Demonstrate effects of foreign investment shifts on U.S. financial markets.
  • Figure 4.8: Illustrates impact of price ceiling on credit card interest rates.

This section is part of the "Principles of Economics 3e" textbook by OpenStax, licensed under a Creative Commons Attribution License.