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Unformatted text preview: abstracts from financial frictions. In the
simplest versions of such models, financial conditions can be summarized by a single
interest rate, the equilibrium value of which is determined in a market for credit.
Figure 2A shows the key equilibrium condition. The loan supply schedule LS shows
the amount of lending L that ultimate savers are willing to finance (by refraining
from expenditure themselves) for each possible value of the interest rate i received
by savers, while the loan demand schedule LD shows the demand for such funds
for each possible value of the interest rate that must be paid by borrowers. Note
that the slopes for the curves LS and LD both reflect the same principle, which is
that a higher interest rate gives both savers and borrowers a reason to defer current
spending to a greater extent. Equilibrium in the credit market then determines
both a market-clearing interest rate and an equilibrium volume of lending, as shown
by i1 and L1 in the figure.
In Figure 2A, the loan supply and demand curves are specified while holding
constant a great many variables ot...
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