Transcript Loanable Funds

The
Loanable Funds
Market
Copyright © 2004 South-Western
Mod
29
Two Models of the Interest Rate
Liquidity Preference Model
Loanable Funds Market
Copyright © 2004 South-Western
THE MARKET FOR LOANABLE
FUNDS
• The market for loanable funds is the market
in which those who want to save supply funds
and those who want to borrow to invest demand
funds.
• Loanable funds refers to all income that people
have chosen to save and lend out, rather than
use for their own consumption.
• Financial markets coordinate the economy’s
saving and investment in the market for
loanable funds.
Copyright © 2004 South-Western
Supply and Demand for Loanable Funds
• The SUPPLY of loanable funds comes from
people who have extra income they want to
save and lend out.
• The DEMAND for loanable funds comes
from households and firms that wish to borrow
to make investments.
Copyright © 2004 South-Western
Supply and Demand for Loanable Funds
• The interest rate is the “PRICE” of a loan.
• It represents the amount that borrowers pay for
loans and the amount that lenders receive on
their saving.
• The interest rate in the market for loanable
funds is the real interest rate.
• The equilibrium of the supply and demand for
loanable funds determines the real interest
rate
Copyright © 2004 South-Western
The Market for Loanable Funds
Real
Interest
Rate
Supply
RIR
%
Demand
0
Q
Loanable Funds
(in billions of dollars)
QLF
Copyright©2004 South-Western
Supply and Demand for Loanable Funds
•
Government Policies That Affect Saving and
Investment
1. Taxes and saving
2. Taxes and investment
3. Government budget deficits
Copyright © 2004 South-Western
Policy 1: Saving DISincentives
• Taxes on interest income substantially reduce
the future payoff from current saving and, as a
result, reduce the incentive to save.
Copyright © 2004 South-Western
Policy 1: Saving Incentives
• A tax decrease increases the incentive for
households to save at any given interest rate.
• The supply of loanable funds curve shifts to the
right.
• The equilibrium interest rate decreases.
• The quantity demanded for loanable funds
increases.
• If a change in tax law encourages greater
saving, the result will be lower interest rates
and greater investment.
Copyright © 2004 South-Western
An Increase in the Supply of Loanable Funds
Interest
Rate
Supply, S1
S2
1. Tax incentives for
saving increase the
supply of loanable
funds . . .
5%
4%
2. . . . which
reduces the
equilibrium
interest rate . . .
Demand
0
$1,200
$1,600
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
Policy 2: Investment Incentives
• An investment tax credit increases the incentive
to borrow.
• Increases the demand for loanable funds.
• Shifts the demand curve to the right.
• Results in a higher interest rate and a greater
quantity saved.
• If a change in tax laws encourages greater
investment, the result will be higher interest
rates and greater saving.
Copyright © 2004 South-Western
An Increase in the Demand for Loanable Funds
Interest
Rate
Supply
1. An investment
tax credit
increases the
demand for
loanable funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
0
D2
Demand, D1
$1,200
$1,400
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
Policy 3: Government Budget Deficits
• A budget deficit increases the demand for
loanable funds.
• Shifts the demand curve to the right.
• Increases the equilibrium interest rate.
• Reduces the equilibrium quantity of loanable funds.
• The deficit borrowing crowds out private
borrowers who are trying to finance
investments.
Copyright © 2004 South-Western
The Effect of a Government Budget Deficit
Interest
Rate
Supply
1.Government
borrowing
increases the
demand for
loanable funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
0
D2
Demand, D1
$1,200
$1,400
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright © 2004South-Western
South-Western
Copyright©2004
Policy 4: Government Budget Surpluses
• A budget surplus increases the supply of
loanable funds:
• Shifts the supply curve to the right
• Decreases the equilibrium interest rate.
• Increases the equilibrium quantity of loanable
funds.
• When government increases national saving by
running a surplus, the interest rate falls and
investment rises.
Copyright © 2004 South-Western
The Effect of a Government Budget Surplus
Interest
Rate
Supply, S1
S2
1. A budget surplus
iincreaser the
supply of loanable
funds . . .
5%
4%
2. . . . which
reduces the
equilibrium
interest rate . . .
Demand
0
$1,200
$1,600
Loanable Funds
(in billions of dollars)
3. . . . and raises the equilibrium
quantity of loanable funds.
Copyright©2004 South-Western
A Summary of Shifts of Supply or Demand
for Loanable Funds
• Shifts of Supply:
• Changes in Savings Behavior
• Changes in Capital Inflows
• Shifts of Demand
• Changes in Business Opportunities for investment
• Changes in Government Borrowing
Copyright © 2004 South-Western
The Loanable Funds Graph
• Worksheet Practice
Copyright © 2004 South-Western