The Market for Loanable Funds
Chapter 13
The Market for Loanable Funds
• Financial markets coordinate the
economy’s saving and investment in the
market for loanable funds.
• Loanable funds refers to all income that
people have chosen to save and lend out,
rather than use for their own
consumption.
The Supply and Demand of Loanable
Funds
•The supply of loanable funds comes from
people who have extra income they want
to save and lend out (savings).
•The demand for loanable funds comes
from households and firms that wish to
borrow to make investments (borrowing) .
Market for Loanable Funds...
Real
Interest
Rate
Supply (savings)
4%
Demand (borrowing)
0
$1,000
Loanable Funds (in
billions of dollars)
Supply and Demand for Loanable Funds
The interest rate is the price of the loan.
• It represents the amount that borrowers pay
for loans and the amount that lenders
(savers) receive on their saving.
• As interest rates rise savers (suppliers) will
be more willing to save and vice versa.
• As interest rates fall borrowers (demanders)
will be more willing to borrow and vice
versa.
•
Market for Loanable Funds
Real Interest Rates
6%
Quantity of
loanable funds
supplied
1400
Quantity of
loanable funds
demanded
600
5%
1200
800
4%
1000
1000
3%
800
1200
2%
600
1400
Taxes and Saving
•Taxes on interest income substantially
reduce the future payoff from current saving
and, as a result, reduce the incentive to save
(supply curve shifts left). The result will be
higher interest rates and smaller investment.
•If a change in tax law encourages greater
saving (supply curve shifts right), the result
will be lower interest rates and greater
investment.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
An Increase in the Supply of Loanable Funds...
Interest
Rate
Supply, S1
S2
1. Households
decide to save more
of their income.
4%
3%
Demand
2. ...which
reduces the
equilibrium
interest rate...
0
$1,000
Loanable Funds
$1,200
(in billions of dollars)
3. ...and raises the equilibrium quantity of loanable funds.
Taxes and Investment
• A change in tax laws can encourage
greater investment (a reduction in the
capital gains tax).
• This would shift the demand curve
right and the result will be higher
interest rates and greater saving.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
An Increase in the Demand for Loanable
Funds...
Interest
Rate
6%
5%
2. ...which
raises the
equilibrium
interest rate...
0
Supply
1. An investment tax
credit increases the
demand for loanable
funds...
D2
Demand, D1
$1,400
$1,200
Loanable Funds
(in billions of dollars)
3. ...and raises the equilibrium
quantity of loanable funds.
Government Budget Deficits and Surpluses
•
•
•
Government borrowing to finance its budget
deficit reduces the supply of loanable funds
available to finance investment by households
and firms.
Interest rates rise and investment falls.
This fall in investment is referred to as
crowding out.
 The
deficit borrowing crowds out private
borrowers who are trying to finance investments.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Effect of a Government Budget Deficit...
Interest
Rate
S2
6%
5%
2. ...which
raises the
equilibrium
interest rate...
$800
$1,200
0
3. ...and reduces the equilibrium
quantity of loanable funds.
Supply, S1
1. A budget deficit
decreases the
supply of loanable
funds...
Demand
Loanable Funds
(in billions of dollars)