The Loanable fund Market Flashcards
Chapter 4
What does the Loanable Funds Market show economists?
The Loanable Funds Market shows how the real interest rate adjusts to balance saving (supply of funds) and investment (demand for funds) in an economy.
What is a loanable fund?
A loanable fund is money that is available to be borrowed in the economy.
Who are the suppliers of loanable funds, and how do they supply the market?
Suppliers of loanable funds are mainly households (who save income) and sometimes the government (if it runs a budget surplus).
Who demands loanable funds, and why?
Firms are the main demanders of loanable funds.
They borrow to invest in things like:
Capital equipment
Buildings and factories
New technology
Sometimes, the government also demands funds when it runs a budget deficit (borrowing to cover spending).
How is the price of loanable funds set?
The price of loanable funds is the real interest rate (r) — it is set by the interaction of supply and demand in the loanable funds market. (Equilibrium point)
(Supply = saving)=(Demand = investment)
What is the equilibrium point in the loanable funds market?
The equilibrium point is where the quantity of loanable funds supplied equals the quantity demanded.
At this point:
Saving = Investment The real interest rate (r) has adjusted to balance the market There is no excess saving or excess demand for funds
What does the demand for loanable funds depend on?
The demand for loanable funds depends mainly on the real interest rate (r).
Why?
Because firms borrow to invest, and investment becomes less attractive as r increases (borrowing is more expensive)
What is the consumption function?
C=c(Y−T)
What type of coloration does the demand for loanable funds have with the real interest rate?
Negative correlation
Where:
I ↓ when r ↑ I ↑ when r ↓
What is the formula for private saving?
Private saving = (Y – T) – C
Y – T = income after taxes (disposable income)
C = how much households consume out of that income
What does the consumption function tell us about private saving?
Consumption directly reduces private saving. The more households consume out of their disposable income, the less they save. This relationship is captured by the marginal propensity to consume (MPC).
What is the formula for Public saving?
T-G
What two savings create the product of national saving (S) ?
Private saving + Public saving
((Y-T)-C +T-G )= S = S-C-G
Is the supply of loadable funds elastic of inelastic in the model and why?
The supply of loanable funds is Inelastic Vertically
G and T are fixed (exogenous) and and private saving does not have a correlation with the real interest rate.
What does the x-axis represent on the loanable funds market graph?
The x-axis shows the quantity of loanable funds (in £).
This includes:
Saving (S) → from households and government
Investment (I) → by firms and government borrowing
At equilibrium: S=I
What does the y-axis represent on the loanable funds market graph?
The y-axis shows the real interest rate (r) — the “price” of borrowing money.
It determines:
How much firms want to borrow (I)
What does the supply curve represent on the loanable funds market graph?
The supply curve represents total national saving:
S=(Y−T−C)+(T−G)
Comes from households (private saving) and government (public saving)
Can be vertical (fixed saving) or upward sloping (if saving responds to r)
What does the demand curve represent in the loanbale fund market graph?
The demand curve shows investment demand:
I=I(r)
Firms borrow more when r is low
Borrow less when r is high
So the demand curve slopes downward.
What is the equilibrium point in the loanable funds market?
Equilibrium is where saving = investment: S=I
At this point, the real interest rate has adjusted so that:
All saving is used for investment
The market for loanable funds is in balance
The goods market is also in equilibrium:
Y=C+I+G
Why would the supply of the lonanble funds market shift left?
Tax cuts (↓ T → ↑ C → ↓ S), like in Liz Truss’s mini-budget
Government runs a budget deficit (T < G)
Households save less (e.g. due to confidence, inflation, or credit access)
What shifts the supply of the loanable funds model?
The supply of loanable funds shifts when national saving changes — due to changes in household behavior or government policy.
Why would the supply of the lonanble funds market shift right?
Households save more (e.g. due to tax incentives or higher future uncertainty)
Government runs a budget surplus (T > G)
Reduction in current consumption
What causes the demand curve for loanable funds to shift?
The demand curve shifts when investment behavior changes for reasons other than the interest rate.
This includes:
Business expectations Government borrowing Tax or policy changes
These affect how much firms and governments want to borrow at any given interest rate.
