Question

Explain the role of the market for loanable funds in sustainable economic growth. (long answer question)

Answer 1

The Market for Loanable Funds

When a firm decides to expand its capital stock, it can finance its purchase of capital in several ways. It might already have the funds on hand. It can also raise funds by selling shares of stock. When a firm sells stock, it is selling shares of ownership of the firm. It can borrow the funds for the capital from a bank. Another option is to issue and sell its own bonds. A bond is a promise to pay back a certain amount at a certain time. When a firm borrows from a bank or sells bonds, of course, it accepts a liability—it must make interest payments to the bank or the owners of its bonds as they come due.Regardless of the method of financing chosen, a critical factor in the firm’s decision on whether to acquire and hold capital and on how to finance the capital is the interest rate. The role of the interest rate is obvious when the firm issues its own bonds or borrows from a bank. But even when the firm uses its own funds to purchase the capital, it is forgoing the option of lending those funds directly to other firms by buying their bonds or indirectly by putting the funds in bank accounts, thereby allowing the banks to lend the funds. The interest rate gives the opportunity cost using funds to acquire capital rather than putting the funds to the best alternative use available to the firm.The interest rate is determined in a market in the same way that the price of potatoes is determined in a market: by the forces of demand and supply. The market in which borrowers (demanders of funds) and lenders (suppliers of funds) meet is the loanable funds market.

Supply of Loanable Funds:

There are four important sources of the supply of loanable funds:

(1) Savings - Higher saving of citizen can decline the growth .

(2) Dishoarding - Hourding act as a dwelling for economic growth

(3) Bank money - Major component of deciding the economic growth

(4) Disinvestment - Lower the economic growth and lead to crowding out situation

Demand for Loanable Funds includes -

Investment Demand: Have a positive relation with ecnomic growth

Dissaving - It means consumption , also lead to economic growth

Hoarding: Hourding act as a dwelling for economic growth

Equilibruim interest rate is determined by demand and supply of the loanable funds . Basically all the components in demand and supply of the loanable funds have connection with economic growth of the country . We can say that lonable funds market play a important role in the sustainable economic growth .