Question

Explain in detail the concept of loanable funds market.List and explain two factors that shift the demand of loanable funds and two factors that shift the supply of loanable funds

Answer 1

The theory of loanable funds market is also know as the theory of market interest rate.All kind of credits ,savings deposits ,loans and bonds are included in the loanable funds.The theory of loanable funds extends the classical theory .In classical theory savings and investment are the factors that determine the interest rate.Loanable fund theory in addition to the investment and savings stated that bank credit will also affect the rate of interest.The demand and of loanable funds is determined by the rate of interest.When the rate of interest is high the demand for the loanable funds is low that is there is an inverse relationship between the demand of loanable funds and the supply of loanable funds .On the other hand supply of loanable funds is positively related to the interest rate.At higher interest rate there is an increased supply of loanable funds.When there is an increased demand for capital stock it implies that there is an increased demand for loanable funds.The firms decision to acquire more capital depends upon the rate of interest.At higher interest rates the firms will decide to acquire lesser amount of capital and thus lower demand for the loanable funds.At lower interest the firms will decide to acquire more amount of capital and thus more demand for the loanable funds.As shown in the figure the demand for loanable funds is negatively sloped as there is an inverse relation between the demand and interest rates.

Supply of loanable funds are directly related to the interest rate and hence it is positively upward sloping as shown in the figure.When interest rates are high lenders will supply more loanable funds to the market.

two factors that shift the demand for loanable funds are the improvements in the technology and changes in expectations.When there is an improvement in the technology the demand curve of the loanable funds will shift to the right as shown in the second figure.The other factors that shift the demand curve of the loanable funds are changes in government spending .An increased return on rate of investment will increase demand for loanable goods

The two factors that shift the supply of loanable funds are i)changes in private savings behaviour:When there is less savings and more spending it will cause the supply curve to shift to left ii)changes in capital inflows.More capital inflows will cause supply curve of the loanable funds to shift to right and the rate of interest decreases as shown in the third figure