Chapter 12 The Economics of Depository Institutions Fundamental

Fundamental Issues 1. In the basic economic theory of banking markets, what are the

The Bank Balance Sheet • Balance-sheet constraint: Ø The accounting constraint that a bank’s

Bank Revenues, Costs, and Profits • Bank revenues: Ø A bank’s total interest earnings,

Bank Revenues, Costs, and Profits • Bank profits: Ø A bank’s economic profits equal

Marginal Revenue • Marginal revenue (MR): Ø The gain in total revenues resulting from

A Perfectly Competitive Bank’s Marginal Revenue Schedule Figure 12– 1 Copyright © 2004 South-Western.

Marginal Cost • Marginal cost (MC): Ø The addition to the total cost generated

Marginal Cost for a Perfectly Competitive Bank Figure 12– 2 Copyright © 2004 South-Western.

Profit-Maximizing Lending at a Perfectly Competitive Bank Figure 12– 3 Copyright © 2004 South-Western.

A Perfectly Competitive Bank’s Loan Supply Schedule Figure 12– 4 Copyright © 2004 South-Western.

The Profit-Maximizing Deposit Level Figure 12 – 5 Copyright © 2004 South-Western. All rights

A Perfectly Competitive Bank’s Deposit Demand Schedule Figure 12– 6 Copyright © 2004 South-Western.

The Market Loan Supply Schedule Figure 12– 7 Copyright © 2004 South-Western. All rights

Equilibrium in a Perfectly Competitive Loan Market Figure 12– 8 Copyright © 2004 South-Western.

Effects of a Decrease in the Nonbank Public’s Demand for Loans Figure 12– 9

The Market Deposit Demand Schedule Figure 12– 10 Copyright © 2004 South-Western. All rights

Equilibrium in a Perfectly Competitive Deposit Market Figure 12– 11 Copyright © 2004 South-Western.

Imperfect Competition in Banking? • Imperfectly competitive market: Ø A market in which conditions

Effects of a Decrease in the Nonbank Public’s Supply of Deposits Figure 12– 12

A Monopoly Loan Market Figure 12– 13 Copyright © 2004 South-Western. All rights reserved.

Index Measures of Interest Rates Offered on Online Bank Deposits SOURCE: ffice of the

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Chapter 12 The Economics of Depository Institutions

Fundamental Issues 1. In the basic economic theory of banking markets, what are the sources of bank revenues and costs? 2. What are the loan supply and deposit demand schedules for perfectly competitive banks? 3. How are bank loan and deposit rates determined in perfectly competitive banking markets? 4. How is the interest rate on bank loans determined in a monopoly loan market? Copyright © 2004 South-Western. All rights reserved. 2

The Bank Balance Sheet • Balance-sheet constraint: Ø The accounting constraint that a bank’s assets cannot exceed the sum of its liabilities and net worth. • Real resource expenses: Ø Expenses that a bank must incur in the form of explicit payments of wages and salaries to employees, explicit payments to other owners of factors of production, and opportunity costs of devoting resources of the bank’s owners to that line of business rather than an alternative. Copyright © 2004 South-Western. All rights reserved. 3

Bank Revenues, Costs, and Profits • Bank revenues: Ø A bank’s total interest earnings, or total revenues, on its total quantity of one-period loans must equal: • Bank costs: Ø Explicit interest expenses Ø Real resource expenses for deposits Ø Real resource expenses for loans Copyright © 2004 South-Western. All rights reserved. 4

Bank Revenues, Costs, and Profits • Bank profits: Ø A bank’s economic profits equal its total revenues less its total economic costs. Ø For the typical bank, profits equal loan interest revenues minus total economic costs—loan interest revenues less deposit expenses, real deposit resource costs, and real loan resource costs. Copyright © 2004 South-Western. All rights reserved. 5

Marginal Revenue • Marginal revenue (MR): Ø The gain in total revenues resulting from a one-unit increase in production of a good or service. Ø For a bank, the addition to its revenues from adding an additional dollar of loan assets. Copyright © 2004 South-Western. All rights reserved. 6

Marginal Cost • Marginal cost (MC): Ø The addition to the total cost generated by a oneunit increase in production of a good or service. Ø For a bank, the addition to total cost from obtaining an additional dollar of deposits to lend, which is the sum of marginal deposit interest expense, marginal deposit resource costs, and marginal loan resource costs. Copyright © 2004 South-Western. All rights reserved. 8

Imperfect Competition in Banking? • Imperfectly competitive market: Ø A market in which conditions for perfect competition, such as freedom of entry and exit, fail to hold, so banks can set their own loan or deposit rates to maximize their individual profits. • Monopoly: Ø A market environment in which only a single firm, or a group of firms collectively coordinating their actions, produces a good or service; in banking, a situation in which only one bank or a coordinating group of banks lends and takes in deposits. Copyright © 2004 South-Western. All rights reserved. 19