Question

Use the loanable funds market, explain what happens to the equilibrium interest rate and equilibrium quantity of loanable funds when:

a, Households are optimistic about future economic condition and want to save less.

Answer 1

In Macroeconomics or Monetary Economics, Loanable Funds Market or as alternatively known as the Money Market basically depicts the interaction between money demand and money supply in any economy or the amount of money or loanable funds demanded by the lenders or savers of loanable funds or money and the borrowers of the same in the economy. This interaction in the money or loanable funds market essentially determines the equilibrium interest rate and the quantity of loanable funds in the money or loanable funds market or in relatively simpler terms, the interaction between the demand and supply of money or loanable funds establishes the equilibrium interest rate and the quantity of loanable funds in the market. The borrowers or demanders of loanable funds in the money market basically include the individual consumers, household units and other business organizations, firms or companies which collectively constitute an important source or stimulus of aggregate consumption and investment level in the economy which subsequently contribute to the determination of the aggregate demand(AD) in the goods market and the overall aggregate national output in the economy. Now, in this case, if future household expectations are positive, the aggregate or savings in the economy would fall and the consumption level would increase alternatively. Now, such positive household expectations would understandably lead to higher overall consumer demand for goods and demand which would induce an increase in the overall money demand or demand for loanable funds in the money or loanable funds market as now households would want to undertake more financial borrowings or loans to finance or liquidate the increased consumption level, holding everything else constant. Therefore, money demand or the loanable funds demand curve would shift to the right or upward due to an increase in money or loanable funds demand attributable to positive future household expectations, again considering everything else constant. This would consequently lead to an increase in both the equilibrium interest rate and the quantity of loanable funds in the money market or market for loanable funds as now the overall money or loanable funds demand has increased which would raise the price of money/loanable funds(interest rate) and the quantity of money/loanable funds as well because the higher interest rate now would induce the lenders or suppliers of money or loanable funds to increase the money/loanable funds supply in the market, considering no change in the overall total money or loanable funds supply and other relevant factors in the economy based on the information provided in the question.