Saving, Investment, and the Financial System 4

Saving, Investment, and the Financial System 4 - 4 Supply...

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Unformatted text preview: 4. Supply and demand for loanable funds The following graph shows the market for loanable funds in a closed economy. The upward—sloping orange line represents the supply of loanable funds, and the downward—sloping blue line represents the demand for loanable funds. 1D 9 / Suppl 5 ---------+ INTEREST RATE lF’e rte nl) emand Lo ———————— D 100 200 BUD 4DD SUD EDD TDD SUD QDU1DDD LOANABLE FUNDS (Billions cfdollars] Saving V is the source ofthe supply of loanable funds. As the interest rate falls, the quantity of loanable funds supplied decreases V . I Points: — 0.5,."1 Explanation: Close Explanation A The supply of loanable funds comes from people who want to save and lend out some of their income. Savers sometimes lend directly by purchasing bonds in financial markets, or they lend indirectly by depositing funds with financial intermediaries, such as banks, that use the deposits to make loans. The interest rate indicates the return that lenders receive on their saving. The supply of loanable funds curve slopes upward. M the interest rate rises, the return on saving increases, and the quantity of loanable funds supplied increases. M the interest rate falls, saving becomes less attractive and consumption becomes more attractive, so the quantity of loanable funds supplied decreases. Suppose the interest rate is 5.5%. Based on the previous graph, the quantity of loanable funds supplied is greater V than the quantity of loans demanded, resulting in a surplus V of loanable funds. This would encourage lenders to lower V the interest rates they charge, thereby decreasing V the quantity of loanable funds supplied and increasing V the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of 5% V . fiPoints:—1;'1 ...
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