The Loanable Funds Market
Module 29
Matching Borrowers and Lenders
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
• In the Money Market, we looked at
the supply and demand of liquid
money
• The Fed will expand the money supply
in the hopes of encouraging
investment, thus increasing GDP
• HOWEVER making money available
does not mean loans will be made
Matching Borrowers and Lenders
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
• In other words, simply having money
available does not guarantee it will be
invested
• Remember, in a simple economy
Savings = Investment
• What makes people decide to save or
borrow?
The Real Interest Rate
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
Since loans are for a certain duration,
inflation becomes an important factor:
Thus, we use the real interest rate when
deciding whether to borrow or lend
The Real Interest Rate =
Nominal Interest Rate – Expected Inflation
Rate of Return
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
Potential borrowers will choose to invest
if the rate of return of the proposed
investment is greater than the real
interest rate of the loan
Rate of Return =
(Revenue from Project – Costs from Project) × 100
Costs of Project
Demand for Loanable Funds
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
At low real interest rates, there will be
many projects with rates of return that
are higher.
But at higher interest rates, fewer
projects will qualify.
Thus, as real interest rates decline, the
quantity demanded of loanable funds
increases.
Real
Figure 29.1 The Demand for Loanable Funds
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Supply of Loanable Funds
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
A higher real interest rate means more
people are convinced to save money
rather than keep it liquid
Thus, the supply of loanable funds is
upward sloping
Real
Figure 29.2 The Supply of Loanable Funds
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Market Equilibrium
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
At market equilibrium, the quantity of
loanable funds supplied equals the
quantity of loanable funds demanded
The market matches projects that earn
at or above this real interest rate with
lenders that are willing to lend at that
rate
Real
Figure 29.3 Equilibrium in the Loanable Funds Market
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Shifts in Demand for Loanable Funds
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
• Changes in perceived business
opportunities
– Businesses might be in a rush to invest in
order to adopt new technology or take
advantage of new markets
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
• Changes in government borrowing
– Increased government borrowing
increases the demand for loanable funds
– Crowding out
Real
Figure 29.4 An Increase in the Demand for Loanable Funds
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Shifts in Supply of Loanable Funds
1) Matching
borrowers and
lenders
- Saving and Investing
- Real Interest Rate
- Rate of Return
2) The Market for
loanable funds
- Demand
- Supply
- Equilibrium
- Shifts
3) Short term v. Long
term
• Changes in private savings behavior
– People will sometimes decide to save
more (spend less), especially if they are
uncertain about the future
• Changes in capital inflows
– Other countries want to invest in the
United States
– If we become a more attractive place to
invest, the supply of loanable funds will
increase
Real
Figure 29.5 An Increase in the Supply of Loanable Funds
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Problems
For each of the following scenarios, use a correctly labeled graph
to show how the market for loanable funds is affected. Show in
your graph the impact on the equilibrium interest rate and
quantity of loanable funds.
•
Many businesses are convinced that artifical
intelligence is the next big opportunity
•
Households fear an imminent recession and
begin to cut back on discretionary purchases.
Problems
For each of the following scenarios, use a correctly labeled graph
to show how the market for loanable funds is affected. Show in
your graph the impact on the equilibrium interest rate and
quantity of loanable funds.
•
The Federal government announces another
annual budget surplus.
•
The flow of foreign financial capital into
American financial markets begins to decrease.