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Current time:0:00Total duration:9:54

Video transcript

what I want to do in this video is talk a little bit about money and interest rates and do it in kind of a micro economic framework so that we understand the relationship between the supply of money and demand for money and the price of money which we'll see is what interest rates actually are and once we do that then we'll be able to be more fluent in discussing money and interest rates and supply and demand and price of money in a macroeconomic context so maybe the most confusing thing when you view money in a micro economic context is what is the price what is the price of money and you might already be guessing the price of money is the interest rate and to understand that a little bit better the best way to think about it is you're not necessarily buying money interest is rent on money it is rent on it is rent on money if I said what is the price of an apartment in my neighborhood someone might say it is say a one-bedroom apartment and that actually is pretty close to the prices where I live in a year Northern California if you want even the most basic one-bedroom apartment it's going to run you about $1,200 $1,200 per month $1200 per month which is about what fourteen thousand four hundred dollars per year so we should say per apartment per apartment per per year this is essentially the cost of your apartment now if someone were to go if I went to the bank and I said hey I want to borrow I want to borrow $10,000 maybe I want to buy a car or something they would quote an interest rate they would say okay you could borrow that at an interest rate of I don't know interest rates are pretty low right now they'll say you could borrow that at an interest rate at 5% and to see that this is essentially the cost of renting money we could essentially just say that this is this is five we could view this as five cents five cents per per dollar per dollar per year so once again when you're renting an apartment it was fourteen thousand four hundred dollars per apartment per year now at an interest rate of 5% that is five cents per dollar per year it's the exact same thing this right over here is this right over here is the rent on the rental price on the actual money that I'm borrowing and once you have that in your head and you're feel comfortable with that now we can actually draw a supply and demand graph in kind of the microeconomics context now that we know how to think about the price of money so let's draw let's draw a little supply and demand diagram right over here and we're going to like we often do in our little economic models we do we're going to super oversimplify it we're going to not think about people things like credit risk and the percent and the chance is the probability that people do pay back or won't pay back the money and things like the quiddity and all that well just assume that everyone is going to pay back the money and they all have that they're all risk free they're all gonna do exactly what they said and so in this axis right over here so this is let's call this the market let's call this the mock market for market for borrowing borrowing money money for one year one year as well see and you might already know you they'll have different prices for borrowing money for different lengths of time I might charge you more to borrow money for a year than I would to charge I then I would charge you for borrowing money for a month because maybe I you know I I won't be a have access to that money or there's a bigger risk that something might happen in that year so I'll charge you more for it so I have to fix the year the market for borrowing money for one year and most of these supply and demand graphs the vertical axis we have price but now as we just indicated the price of money is really just the interest rate so let me I'll call this price so this is our under that same yellow so this is our price axis price axis and it's measured as interest rate percentage interest interest rate is how we're going to measure it and let's say this right over here let's say that that is 30 percent interest this is 15 percent interest and then this would be you'll see this would be 10 5 this would be 20 25 pretty good and then over here we would have the quantity of money and I'll just pick some values here let's see if we can even say that that isn't you know I don't know billions of dollars we could size it right based on where they're talking about our town our city or whatever the whole world or whatever it is and it depends on what currency and all of that board is assuming that we're in some island with one currency you know and and and all the rest and let's say that this is 1 billion 2 billion 3 billion 4 billion and 5 billion and so you can imagine let's first think about the demand curve we could think of it as a marginal benefit curve that that those first few dollars that are out to be leant there are someone who's going to get a huge marginal benefit of it they want to take that either they want to borrow it and use it for some type of consumption that they need something that they that would they want to buy that it would make them very very very happy or at least they think it'll make them very happy or they want to use it for some type of an investment where they're like wow if I could just borrow some money I have this no risk investment that's just going to you know make me a gazillionaire so those first few dollars there's huge demand huge marginal benefit for it and so the willingness you could view it as a willingness to pay for those first few dollars is very high so maybe it is way up here people are willing to pay in excess of 30 percent for those first few dollars and then as there's more and more dollars the incremental next borrower gets a little bit less marginal benefit from it and so you would have a declining demand curve that looks something like this and this is the exact same thought processes you would have which we're thinking about the market for ice cream or if we're thinking about the market for apartments or anything else so this is our this is our demand curve and when we and when we think about the supply curve same exact process thought processes we would for as we would for for a supply of any product so those first few dollars the the people lending the money they're like oh well they're probably people they're let willing to lend for very little they have nothing else to do with that money so they would you could another way to think of it they have not very very little to do with that money they're marginal cost of lending that money is very low and so the supply curve might start over here people will start to be willing to lend the money to very low-interest-rate this is looks like about 1% and then each incremental dollar the opportunity cost for that lender is going to get higher and higher and so the interest the interest for that next incremental dollar is going to get higher and higher and so we've now drawn the supply and demand graphs for for the market for borrowing money for one year so this is right here this is this is the supply and this is in billions of dollars let's say billions of dollars per per year so this is how much is going to be lent in that year and it's for borrowing money for a year but as we see we can view money just like we could view any other product there's going to be an equilibrium price here in an equilibrium quantity so the way I drew it right over here the equilibrium price and remember the price of money is really just the interest rate the equilibrium price right over here is 10% which you could view as 10 cents per dollar per year and the equilibrium quantity of money that gets lent and borrowed is looks like I don't know it looks at about 2.7 or 2.8 billion dollars gets lent and borrowed in that year in each year and when we look at it this way then we could start thinking about some macroeconomic phenomenon what happens what happens if all of a sudden if all of a sudden everybody everybody in the world or in our little R universe right over here gets a little bit more money thrown in their pocket so you know the government prints about a bunch of money drops it from helicopters and everyone has more money in their pockets well then all of a sudden then all of a sudden at any given interest rate the supply will go up at any given interest rate the supply will go up so the supply curve will shift in this direction so we might have a new supply curve that looks something like this so we might have a new supply curve that looks something like this and then also we could say well and also maybe the demand will go down so Denny at any given interest rate any given price there will be less demand because those people who needed to borrow money now they have to borrow less money and so this will shift this will shift to the left and so the new demand serve the new demand curve might look like that now what happened what would be our new equilibrium price and it depends how much I shift one or the other but the way I drew it our equilibrium quantity doesn't change much but it could change depending on how much the supply or demand shifts but what does definitely happen when that money got printed and distributed to all of these people is now all of a sudden the equilibrium interest rate has gone down the equilibrium interest rate now based on the way I drew it looks like it's closer to about I don't know about 6% so the whole and you could even think of another reality where all of a sudden money disappears from the market or a reality for for whatever reason because of good marketing or psychological shift in people all of a sudden people want to people want to save less so that there is less supply of money or maybe all of a sudden there's all these great investment opportunities so now there is more demand for money and you could think about how these curves would shift and what would happen to the interest rate just how you would think about it for any good or service in a micro economic context