In making an investment decision, a business firm is most interested in the:

Question

nominal interest rate.

real interest rate.

nominal interest rate minus the real interest rate.

the future supply of loanable funds.

Answer 1

A business firm would be most interested in the real interest rate charged on loans.  The nominal interest rate is in fact the actual rate charged at any one point in time to borrow money or the actual interest rate earned on an investment. The real interest rate adjusts for inflation.  If a business buys an asset today for $100 and sells it in one year for $110 then it earned a $10 profit, or 10%.  This is a nominal interest rate on the investment.  If, however, the inflation rate in the economy during that year is $4% then the "real interest rate" earned is 10% less 4%, or 6%  By the same logic if a business borrows money at a 6% rate today and pays it back in one year, where the inflation rate is 4%, then the "real interest rate" on the loan is 6% less 4%, or 2%.

 

In the real world people usually simply talk about "interest rates."  They are really referring to nominal interest rates. Businesses of course have to understand this difference.

 

The future supply of loanable funds refers to the money supply businesses can tap to borrow money to produce goods and services.  Classical economic theory holds that as interest rates go up lending institutions will want to loan more money, so the supply of money would increase.  A larger money supply tends to, over time, lower interest rates.  This constant ebb and flow must be closely monitored by business owners.

 

A good source for definitions of these terms can be found at investopedia.com.  I have tutored microeconomics extensively and can be available for online lessons.