Interest Rate and Loanable Funds

Loanable Funds Market Equilibrium

-Interest rate > equilibrium, S > D = surplus (good for borrowers, bad for lenders). Then the real interest rate falls until its back at the equilibrium -Interest rate < equilibrium, S < D = shortage (good for lenders, bad for borrowers). Then the real interest rate rises until its back at the equilibrium

Nominal Interest Rate

# of dollars that a borrower pays and a lender receives in interest in a year. Nominal interest rate = annual interest rate/loan x100

What determines demand for loanable funds?

- The real interest rate: real interest rate rises, quantity of funds demanded goes down, less profit (moves along curve) - Expected profits: expected profits rise (during expansion), investments go up, funds demanded go up (shifts curve) - rise from tech changes and pop. growth

The Loanable Funds Market

The aggregate of all the individual financial markets.

Supply of loanable funds

The relationship between the quantity of loanable funds supplied and the real interest rate. (When everything else remains the same) - Real interest rate goes up, supply goes up - Expected future income goes up, savings now go down - Wealth increases, savings decrease - Default risk: the risk that a loan will not be repaid. The greater that risk, the higher is the interest rate needed to induce a person to lend and the smaller is the supply. Disposable income: taxes have been taken out and you're paying for rent, food, etc Disposable income decreases → savings decreases

The quantity of loanable funds supplied

The total funds available from private saving, the government budget surplus, and international borrowing during a given period.

The quantity of loanable funds demanded

The total quantity of funds demanded to finance investment, the government budget deficit, and international investment or lending during a given period.

Along vs. shift for the demand curve

Along = quantity of loanable funds demanded Shifts = loanable funds are demanded

Interest Rate

If the asset price rises, the interest rate falls If the asset price falls, the interest rate rises Interest rate = interest/asset x100 If interest rate rises → investments decrease If interest rate falls → investments increase

Expected future interest rates

Increase → demand for loans will go up now while they're low. Decrease → demand for loans will go down now while they're high.

When taking out loans, if the interest rate...

Is low your savings will fall Is high your savings will rise

Real Interest Rate

Real interest rate = nominal interest rate - inflation rate Real interest rate is the opportunity cost of loanable funds. Real interest paid on borrowed funds is the opportunity cost of borrowing.

Demand for loanable funds

Relationship between the quantity of loanable funds demanded and the real interest rate. (other influences remain constant)