Question

using the lonable funds model, describe the relationship between bond prices and interest rate

Answer 1

The market for Loanable Funds is where borrowers and lenders get together. As with other markets, there is a supply curve and a demand curve. In the loanable fundsframework, the supply represents the total amount that is being lent out at differentinterest rates or the amount being saved in the economy while the demand curverepresents the total demand for borrowing at any given interest rate.

In the loanable funds framework, the interest rate adjusts until supply is equal to demand.The supply and demand curves will cross at exactly one point, determining the equilibrium interest rate. At this equilibrium, the total amount that is being lent out (the quantity supplied) is equal to the total amount that is being borrowed (the quantity demanded). If the interest rate is higher or lower than this equilibrium point there will be either more demand than supply (excess demand) or less demand than supply (excess market supply) in the market.

The nominal interest rate is the interest rate interest rate in terms of dollars. This is the i nterest rate that is usually reported in the newspaper.The real interest rate is equal to the nominal interest rate adjusted for inflation.

Real Interest Rate = Nominal Interest Rate – Inflation

Summary:The interest rate is determined by the interaction of the demand and supply of loanable funds.

a) . Increases in demand will increase both the interest rate and the total amount of borrowing and lending and vice-versa.

b).  Increases in supply will decrease the interest rate and increase the total amount of borrowing and lending. Decreases in supply will increase the interest rate and decrease the total amount of borrowing and lending.