The Market for Loanable
Funds
Supply = Demand
Loanable Funds Demand Curve: Slope
Interest
rate, r
The loanable funds demand curve is
downward sloping. Why?
Demand for loanable funds, D
Quantity of
loanable funds
Loanable Funds Supply Curve: Slope
Supply of loanable funds, S
Interest
rate, r
The loanable funds supply curve is upward
sloping. Why?
Quantity of
loanable funds
Shifts of the Loanable Funds Demand Curve
1. Changes in Perceived Business Opportunities
a. Think changes about beliefs in “rate of return”
2. Changes in the Government’s Borrowing
a. “Crowding Out”
Shifts of the Loanable Funds Supply Curve
1. Changes in Private Savings Behavior
a. What would make you save more? Less?
2. Changes in Capital Inflows
a. Is your country a “good investment”?
Equilibrium in the Loanable Funds Market
Loanable Funds Supply curve, S
Interest
rate, r
Equilibrium
rE
E
Loanable Funds Demand curve, D
QE
Quantity of
loanable funds
Loanable Funds Demand Curve: Shifts in the Curve
Supply of loanable funds, S
Interest
rate, r
r2
Right shift of the demand
for loanable funds curve…
…causes an increase in the
interest rate.
r1
D1
D2
Quantity of
loanable funds
Loanable Funds Supply Curve: Shifts in the Curve
Supply of loanable funds, S
S2
Interest
rate, r
Right shift of the supply for
loanable funds curve…
…causes a decrease in the
interest rate.
r1
r2
D1
Quantity of
loanable funds
Short-Run Determination of the Interest Rate
The Liquidity Preference Model of the Interest Rate
MS1
The Loanable Funds Model of the Interest Rate
MS2
Interest
rate, r
S1
The Fed increases
the money supply…
…which lowers the
interest rate…
S2
Interest
rate, r
r1
r1
E1
E1
E2
r2
E2
r2
MD1
M1
M2
Quantity of
money
…and leads to a
short-run increase
in GDP and an
increase in the
supply of loanable
funds.
D
Q1
Q2
Quantity of
loanable funds
Long-Run Determination of the Interest Rate
The Liquidity Preference Model of the Interest Rate
MS1
MS2
The Loanable Funds Model of the Interest Rate
Interest
rate, r
In the long run, the
Interest
rise in the price level
rate, r
shifts the money
demand curve to
the right…
r1
r1
E1
E3
M2
E2
r2
MD1
M1
S2
E1
…which raises the
interest rate back to
the original level…
E2
r2
S1
Quantity of
money
MD2
…which reduces real
GDP and the supply
of loanable funds
until aggregate
output equals
potential output.
D
Q1
Q2
Quantity of
loanable funds