Question

What is the significance of loanable funds to both national and local enconmies?

Answer 1

Introduction :

The interest rate is determined by the demand for and supply of loanable funds. The term loanable funds includes all forms of credit, such as loans, bonds, or savings deposits.

Loanable Fund Importance: Local Economics

The following graph shows the demand for loanable fund in market

1) Lenders are consumers or firms that decide that they are willing to forgo some current use of their funds in order to have more available in the future. Lenders supply funds to the loanable funds market. In general, higher interest rates make the lending option more attractive.

2) For consumers, however, the decision is a bit more complicated than it is for firms. In examining consumption choices across time, economists think of consumers as having an expected stream of income over their lifetimes. It is that expected income that defines their consumption possibilities

3) consumers is to determine when to consume this income. They can spend less of their projected income now and thus have more available in the future. Alternatively, they can boost their current spending by borrowing against their future income.

4) the relationship between the demand for capital and the loanable funds market thus goes both ways. Changes in the demand for capital affect the loanable funds market, and changes in the loanable funds market can affect the quantity of capital demanded.

Loanable Fund Importance: national economics

investment spending is an important category of real GDP. Not only is it usually the most volatile part of real GDP, but investment spending on physical capital is also an important contributor to economic growth.

The market for loanable funds describes how that borrowing happens. The supply of loanable funds is based on savings. The demand for loanable funds is based on borrowing. The interaction between the supply of savings and the demand for loans determines the real interest rate and how much is loaned out.

In following condition, Loanable Fund is required to Economy

1 Budget deficit

when taxes collected are less than the amount of government spending, the difference between taxes and government spending is a budget deficit

2) Force Majeure

When an economy which does not allow international trade or the movement of financial assets into or out of a country, I.e Recent COVID-19 stopped all activities of international trade

3) Investment

When country needs more money to fund investment projects i.e. New Infrastructure development like, Railways, Airport, Defense

Below are the impact of Interest Rates on Economy

1) 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 of using funds to acquire capital rather than putting the funds to the best alternative use available to the firm.

2) 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.

3) Interest rate plays in the demand for capital by ignoring differences in actual interest rates that specific consumers and firms face in the economy. For example, the interest rate on credit cards is higher than the mortgage rate of interest, and large, established companies can borrow funds or issue bonds at lower interest rates than new, start-up companies

4) Interest rates that firms face depend on a variety of factors, such as riskiness of the loan, the duration of the loan, and the costs of administering the loan

5) various interest rates in the economy tend to move up and down together, the conclusions we reach about the market for loanable funds and how firms and consumers respond to interest rate changes will still be valid.

6) The desire for more capital means, in turn, a desire for more loanable funds. Similarly, at higher interest rates, less capital will be demanded, because more of the capital in question will have negative net present values. Higher interest rates therefore mean less funding demanded.

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