4.7 The Loanable Funds Market

a. Define (using graphs as appropriate) the loanable funds market, demand for loanable funds, and supply of loanable funds. b. Explain (using graphs as appropriate) the relationship between the real interest rate and the quantity of loanable funds demanded (supplied).

• The loanable funds market describes the behavior of savers and borrowers.
• The demand for loanable funds shows the inverse relationship between real interest rates and the quantity demanded of loanable funds.
• The supply of loanable funds shows the positive relationship between real interest rates and the quantity supplied of loanable funds.
• Enduring understanding MKT-4: The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.

Define national savings in both a closed and an open economy.

• In the absence of international borrowing and lending, national savings is the sum of public savings and private savings.
• For an open economy, investment equals national savings plus net capital inflow.
• Enduring understanding MKT-4: The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.

Define (using graphs as appropriate) equilibrium in the loanable funds market.

• In the loanable funds market, equilibrium is achieved when the real interest rate is such that the quantities demanded and supplied of loanable funds are equal.
• Enduring understanding MKT-4: The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.

Explain (using graphs as appropriate) how real interest rates adjust to restore equilibrium in the loanable funds market.

• Disequilibrium real interest rates create surpluses and shortages in the loanable funds market. Market forces drive real interest rates toward equilibrium.
• Enduring understanding MKT-4: The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.

a. Explain (using graphs as appropriate) the determinants of demand and supply in the loanable funds market. b. Explain (using graphs as appropriate) how changes in demand and supply in the loanable funds market affect the equilibrium real interest rate and equilibrium quantity of loanable funds.

• The loanable funds market can be used to show the effects of government spending, taxes, and borrowing on interest rates.
• Factors that shift the demand (such as an investment tax credit) and supply (such as changes in saving behavior) of loanable funds change the equilibrium interest rate and the equilibrium quantity of funds.
• Enduring understanding MKT-4: The interaction of borrowers, who demand loanable funds, and savers, who supply loanable funds, determines the equilibrium real interest rate.