The Loanable Funds Market Mr. Clifford 3 Minute Video Khan Academy - - PowerPoint PPT Presentation

The Loanable Funds Market

• Mr. Clifford 3 Minute Video

Khan Academy 7 Minute Video

What Is an Interest Rate? The interest rate is the amount a lender charges to the borrower for the use of assets expressed as a percentage of the amount borrowed. The “price” of taking out a loan.

Supply

(Private Savings & Government Surpluses) The direct relationship between real interest rate and quantity loans supplied.

Demand

(Private Borrowing & Government Deficits) The inverse relationship between real interest rate and quantity loans demanded.

Real Interest Rate

DBorrowers/Investors SLenders/Savers

Loanable Funds Market

Quantity of Loans

QLoans re At the equilibrium real interest rate (nominal rate – inflation rate), the amount borrowers want to borrow equals the amount lenders want to lend.

Loanable Funds Market Shifters

• 1. Changes in private

savings behavior

• 2. Changes in public

savings (surpluses)

• 3. Changes in foreign

investment (ex: more inflow of foreign financial capital)

• 1. Changes in borrowing

by consumers

• 2. Changes in borrowing

by businesses (investment spending)

• 3. Changes in borrowing

by the government (ex: deficit spending)

Demand Shifters Supply Shifters

Demand for loans comes from borrowers/investors Supply for loans comes from lenders/savers

Real Interest Rate

SLenders

Quantity of Loans

QLoans S1 re r1 Q1

Example #1: China Reduces Purchases of US federal Bonds Less foreign financial inflow & the supply of loanable funds falls. Real Interest Rates RISE & Quantity of Loans DROPS

DBorrowers/Investors

Example # 2: If the US government runs a surplus, what will be the impact on the loanable funds market? Show the results on the graph below. How will this change impact GDP?

Example #3: If the government increases tax credits for new homeowners, what will the impact be on the loanable funds market? Show of the graph below. Show of the graph below. How will this impact GDP?

Example # 2: If the government runs a surplus, what will be the impact on the loanable funds market? Show the results on the graph below. How will this change impact Real Interest Rates & GDP? Example #3: If the government increases tax credits for new homeowners, what will the impact be on the loanable funds market? Show of the graph below. How will this impact Real Interest Rates & GDP?

S will Shift RIGHT to S1 Real Interest Rates will FALL, & GDP will INCREASE because investment (“I” in C+I+G+NX) increases will lower interest rates D will Shift RIGHTto D1 Real Interest Rates RISE & GDP will FALL because investment (“I” in C+I+G+NX) drops as interest rates grow

Example #4: What will happen to the demand and supply for loanable funds if there is political instability? (Ex: Venezuaela) Demand and Supply BOTH shift

• Demand will decrease as

worried consumers and businesses borrow/invest less

• Supply will decrease as

worried foreigners take money out of the country (This is called “capital flight”) Impact on real interest rate is unclear

Quantity of loans falls D1

Real IR

Quantity of Loans

S ir

R

D S1

2010 FRQ #1

2010 FRQ #1 ANSWER VIDEO

2010 FRQ #1 ANSWER

BONUS Practice FRQ

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BONUS Practice FRQ ANSWER