Post on 03-Jan-2016
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