Loanable funds market | Financial sector | AP Macroeconomics | Khan Academy

Market for Loanable Funds

• Definition: Market for loanable funds refers to the market where people supply funds to be lent out to borrowers and demand funds that they want to borrow.

Key Participants

• Suppliers (Savers): Individuals who save money and deposit it in banks or financial institutions, which then lend this money to borrowers.

  • Banks offer interest on deposits and charge interest on loans, facilitating a return for savers.

• Demanders (Borrowers): Individuals or businesses seeking funds, often for investment opportunities.

  • Borrowers typically do not interact directly with savers; transactions usually go through financial institutions.

Structure of the Loanable Funds Market

• Axes Representation:

  • Horizontal axis: Quantity of loanable funds

  • Vertical axis: Price (Interest Rate)

    • The relevant price in this context is the real interest rate, which factors out the effect of inflation.

Behavior of Savers and Borrowers

• Savers:

  • Lower real interest rates lead to reduced motivation to save; thus, the quantity supplied is low.

  • Higher real interest rates incentivize savers to increase their savings, boosting the quantity supplied.

• Borrowers:

  • High real interest rates result in lower demand for loans as fewer business opportunities justify the borrowing costs.

  • Lower real interest rates increase the quantity demanded as more businesses find it viable to pursue loans.

Equilibrium in the Market

• Equilibrium Point:

  • The market reaches equilibrium where the supply and demand for loanable funds intersect, determining the equilibrium quantity of funds and the equilibrium real interest rate.

Shifts in Demand for Loanable Funds

• Factors Causing Rightward Shift:

  • Increased business opportunities (e.g., asteroid mining) lead to higher demand for loans.

  • Increased government borrowing shifts demand to the right, as the government requires funds for expenditure.

• Result of Demand Shift:

  • If demand increases while the interest rate remains unchanged, a shortage occurs, leading to an increase in the equilibrium interest rate and quantity of loanable funds.

Shifts in Supply of Loanable Funds

• Factors Causing Rightward Shift:

  • Initiatives emphasizing the need to save (e.g., government campaigns) can encourage higher savings rates, increasing supply.

• Result of Supply Shift:

  • If supply increases while the interest rate remains unchanged, a surplus of loanable funds arises, prompting the interest rate to decrease as lenders compete to offer their funds.

Conclusion

• The loanable funds market operates similarly to other markets, with the distinguishing factor being the interest rate as its 'price'. Understanding shifts in supply and demand helps illustrate changes in equilibrium and interest rates.