The Market for Loanable Funds

Supply = Demand

Loanable Funds Demand Curve: Slope

Demand for loanable funds, D

The loanable funds demand curve is downward sloping. Why?

Interest rate, r

Quantity ofloanable funds

Loanable Funds Supply Curve: SlopeInterest rate, r

Quantity ofloanable funds

Supply of loanable funds, S

The loanable funds supply curve is upward sloping. Why?

Shifts of the Loanable Funds Demand Curve1. Changes in Perceived Business Opportunities

a. Think changes about beliefs in “rate of return”

2. Changes in the Government’s Borrowinga. “Crowding Out”

Shifts of the Loanable Funds Supply Curve1. Changes in Private Savings Behavior

a. What would make you save more? Less?

2. Changes in Capital Inflowsa. Is your country a “good investment”?

EEquilibrium

Loanable Funds Demand curve, D

Loanable Funds Supply curve, S

Equilibrium in the Loanable Funds MarketInterest rate, r

Quantity ofloanable funds

rE

QE

Loanable Funds Demand Curve: Shifts in the Curve

Right shift of the demand for loanable funds curve…

D2D1

Interest rate, r

Quantity ofloanable funds

r2

r1

Supply of loanable funds, S

…causes an increase in the interest rate.

Loanable Funds Supply Curve: Shifts in the Curve

Right shift of the supply for loanable funds curve…

D1

Interest rate, r

Quantity ofloanable funds

r2

r1

Supply of loanable funds, S S2

…causes a decrease in the interest rate.

M2

E1

Interest rate, r

Quantity ofloanable funds

Quantity ofmoney

Interest rate, r

r2

r1

MS1 MS2

E2

r1

D

E1

M1

MD1

Q1

r2E2

Q2

S1 S2

The Fed increases the money supply…

Short-Run Determination of the Interest Rate

…which lowers the interest rate…

…and leads to a short-run increase in GDP and an increase in the supply of loanable funds.

The Liquidity Preference Model of the Interest Rate The Loanable Funds Model of the Interest Rate

M2

E1

Interest rate, r

Quantity ofloanable funds

Quantity ofmoney

Interest rate, r

r2

r1

MS1 MS2

E2

r1

D

E1

M1

MD1

Q1

r2E2

Q2

S1 S2In the long run, the rise in the price level shifts the money demand curve to the right…

Long-Run Determination of the Interest Rate

…which raises the interest rate back to the original level…

…which reduces real GDP and the supply of loanable funds until aggregate output equals potential output.

The Liquidity Preference Model of the Interest Rate The Loanable Funds Model of the Interest Rate

MD2

E3