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.