Expected Future Profits

Definition

Expected future profits refer to the anticipated earnings that businesses expect to generate from their investments over time. These expectations influence firms' decisions regarding investment and expansion, as higher anticipated profits often lead to increased demand for loanable funds, which plays a critical role in the loanable funds market.

5 Must Know Facts For Your Next Test

1. Expected future profits are a key determinant in a firm's decision to invest; if firms anticipate higher profits, they are more likely to seek loans for expansion.
2. When businesses expect future profits to rise, they increase their demand for loanable funds, shifting the demand curve to the right in the loanable funds market.
3. Conversely, if firms expect lower future profits, they may reduce their investment plans, leading to a decrease in demand for loans.
4. Expectations about future profits can be influenced by various factors, including economic conditions, consumer demand, and competitive pressures.
5. Changes in expected future profits can lead to fluctuations in interest rates as lenders adjust their rates based on perceived risks associated with borrowers' investment plans.

Review Questions

• How do expected future profits influence a firm's investment decisions and its demand for loanable funds?
  • Expected future profits significantly influence a firm's investment decisions. When firms anticipate higher profits from an investment, they are more likely to borrow money, leading to increased demand for loanable funds. This increased demand can shift the demand curve in the loanable funds market, potentially raising interest rates as lenders respond to greater borrowing requests.
• Evaluate how changes in expected future profits can impact overall economic activity within the loanable funds market.
  • Changes in expected future profits can have a substantial impact on overall economic activity. For instance, when businesses expect stronger profits, they tend to invest more, leading to greater demand for loanable funds. This increased borrowing can stimulate economic growth as firms expand operations and hire more workers. Conversely, if expectations decline, reduced investment may slow down economic growth and lead to higher unemployment.
• Synthesize the relationship between expected future profits and interest rates within the context of the loanable funds market.
  • The relationship between expected future profits and interest rates is complex and interconnected. When businesses forecast higher expected future profits, they increase their borrowing activity in the loanable funds market, leading to higher demand for loans. This increased demand can push interest rates upward as lenders respond to heightened risk and competition for available funds. Conversely, if expected future profits decline, reduced demand for loans can result in lower interest rates. Thus, understanding this relationship is vital for analyzing economic trends and making informed financial decisions.

Related terms

Investment:

The allocation of resources, typically capital, with the expectation of generating income or profit in the future.

Interest Rate:

The cost of borrowing money, usually expressed as a percentage of the amount borrowed, which is influenced by supply and demand in the loanable funds market.

Loanable Funds:

The funds available for borrowing in the financial system, which are supplied by savers and demanded by borrowers to finance investments.