Economics
Demand in the Loanable Funds Market
Demand in the loanable funds market represents the quantity of funds that borrowers are willing to borrow at various interest rates. As interest rates decrease, the demand for loanable funds increases because borrowing becomes more affordable. This relationship is illustrated by the downward slope of the demand curve in the loanable funds market.
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7 Key excerpts on "Demand in the Loanable Funds Market"
eBook - PDFThe Fear Factor
What Happens When Fear Grips Wall Street
- C. Read(Author)
- 2009(Publication Date)
- Palgrave Macmillan(Publisher)
We return to this concept in the next chapter and in chapters 6 and 8. Our individual reasons to borrow and invest today and repay tomorrow give rise to our demand for loanable funds and for the existence of financial Figure 3.3 Aggregate Demand Price p $20 $10 Demand curve 15 bottles 30 bottles Demand q 26 The Supply and Demand of Loanable Funds markets. Of course, higher interest rates mean fewer activities that can offer returns sufficient to cover the interest payments. Just as with any demand curve, the demand for loanable funds is simply the horizontal sum of the amount each of us would be willing to borrow at each interest rate. The graph of the demand for loanable funds is downward sloping, indicat- ing greater demand for borrowing when interest rates fall. As this borrowing is based on our perceived ability to repay the loan, a number of factors affect this relationship. For instance, we can expect an increased willingness to borrow if we expect the assets we plan to purchase to appreciate. Students expecting growing salaries in their field of choice will be more inclined to borrow at a given interest rate. Alternately, if we expect home values to increase at a more dramatic pace in the future, we would be more willing to borrow to buy now so we can better capitalize on its appreciation later. We may even want to borrow now if we expect an increase in the cost of future borrowing or in the cost of the goods we intend to purchase later. Borrowing to produce Adding to the demand for loanable funds are the capital needs of commerce. Production of goods and services requires investment in factories, supply and distribution chains, inventories, and retail outlets. These investments in productive capacity are investments in the economists’ sense, but not investments in the financial sense.
- Michael Brandl(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 47 CHAPTER 3 Bonds and Loanable Funds To determine the impact of these changes in the supply of loanable funds, we need to inves-tigate the other side of the market, or the demand for loanable funds. 3-4b The Demand for Loanable Funds Borrowers in financial markets take funds from our pool of loanable funds. These borrowers, or deficit units, are entities who have an optimal level of expenditure in the current period that is greater than their current income. These borrowers or deficit units include the following. Households When a household’s utility-maximizing level of consumption is greater than its current after-tax income, it might borrow the difference from the financial market. Or, it might withdraw savings it has from previous time periods. In terms of loanable funds, it is withdrawing funds from the pool of loanable funds. Firms When a firm has a profit-maximizing level of expenditures that is greater than its income in the current period, it too must borrow to make up the difference. In this case, firms borrow from the pool of loanable funds. Governments When a government runs a budget deficit, it is spending more than what it is collecting in tax revenues. To make up this difference, the government has to borrow funds in the financial markets or borrow money from the pool of loanable funds. Governments—be they national, state, or local governments or government agencies—may withdraw or borrow funds from the pool of loanable funds.
- Michael Brandl(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 43 CHAPTER 3 Bonds and Loanable Funds To determine the impact of these changes in the supply of loanable funds, we need to investigate the other side of the market, or the demand for loanable funds. 3-4b The Demand for Loanable Funds Borrowers in financial markets take funds from our pool of loanable funds. These borrowers, or deficit units, are entities who have an optimal level of expenditure in the current period that is greater than their current income. These borrowers or deficit units include the following. Households When a household’s utility-maximizing level of consumption is greater than their current after-tax income, they might borrow the difference from the financial market. Or, they might withdraw savings they have from previous time periods. In terms of loanable funds, they are withdrawing funds from the pool of loanable funds. Firms When a firm has a profit-maximizing level of expenditures that is greater than their income in the current period, they too must borrow to make up the difference. In this case, firms borrow from the pool of loanable funds. Governments When a government runs a budget deficit they are spending more than what they are collecting in tax revenues. To make up this difference, the government has to borrow funds in the financial markets or borrow money from the pool of loanable funds. Governments—be they national, state, or local governments or government agencies—may withdraw or borrow funds from the pool of loanable funds.
eBook - PDF- Jeffrey Yi-Lin Forrest(Author)
- 2014(Publication Date)
- CRC Press(Publisher)
Interest: A factor influencing monetary supply and demand 151 5.2 L I Q U I D ITY PREFERENCE Based on the supply and demand relationship of bonds, the theory of loanable funds analyzes the mechanism that determines the interest rate. That is one theoretical frame-work for the investigation of how interest rate is determined. Keynes proposes and establishes another theoretical framework, which analyzes the mechanism of how inter-est rate is determined through the use of the supply and demand relationship of money. This theoretical model is known as the theory of liquidity preference. Although these two frameworks of analysis look different, the analysis of the money market using the liquidity preference is closely related to the theory of loanable funds of the bond market. To a certain degree, these two theories provide the same conclusion regarding how to determine the equilibrium interest rate. Even so, these theories have their differ-ent strengths and weaknesses. For example, when analyzing how changes in expected inflation affect the interest rate, the theory of loanable funds is more convenient and readily to apply. When analyzing how changes in income, price level, and supply of money affect the interest rate, the theory of liquidity preferences provides a more straightforward method of analysis. Keynes divides the assets people use to store wealth into two classes: money and bonds. With this assumption, Keynes believes that the total amount of wealth in an economy is equal to the sum of total quantity of bonds and total amount of money, which is the sum of the bond supply B s and the money supply M s . Because the amount of assets people purchase is limited by the total amount of wealth they own, the sum of the amount B d of bonds and the amount M d of money people are willing to hold must be the same as the total of wealth. That is, B d represents the demand for bonds, and M d the demand for money.
Available until 4 Dec |Learn more- Jagdish Handa(Author)
- 2002(Publication Date)
- Routledge(Publisher)
The rate of interest is a price. But what is the good with which it should be identified in a dynamic context? The liquidity preference approach would identify it with the good ‘money’, specifying dynamic changes in the rate of interest as a function of the excess demand for money, as given by (28) above. The loanable funds approach would define the relevant good as ‘credit’, ‘loanable funds’ or ‘bonds’, relating the dynamic changes in the rate of interest to the excess demand for bonds, as given by (29). As we have shown above, these two approaches yield different rates of change in the rate of interest.At a practical level, the dispute between the traditional classical and Keynesian theories of the rate of interest comes down to which approach will do better empirically in a dynamic context. But there is no generally accepted empirical evidence on this issue, so that we should not ignore our intuition on it. Our intuition on the operational markets in the economy has already been specified in Chapter 17 and is along the following lines.Commodities are always bought and sold at a price against a specific good that is labelled as money in a monetary economy. There are, therefore, operational markets for commodities (or an operational market for ‘the commodity’ in a single commodity model), so that the equilibrating variables are commodity prices in commodity markets. Loans are made, again always in a specific good that is money in a monetary economy, and the rate of interest is agreed between borrowers and lenders. It is then the ‘price’ of credit or loans. There is, therefore, an operational market for loanable funds (bonds), with the interest rate as the equilibrating variable.Note that there is no real-world market where money is always bought and sold against one specific good. Individuals run down their money balances by either buying goods in the commodities markets or by making loans in the credit market. These arguments show that the economists’ market for money balances is an analytical construct without an operational real-world counterpart . It is an ‘image’ provided by the merged reflection of two (or several) entities or figures (markets) standing in front of a mirror.12
eBook - PDF- Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
If the interest rate (remember, this measures the “price” in the financial market) is above the equilibrium level, then an excess supply, or a surplus, of financial capital will arise in this market. For example, at an interest rate of 21%, the quantity of funds supplied increases to $750 billion, while the quantity demanded decreases to $480 billion. At this above-equilibrium interest rate, firms are eager to supply loans to credit card borrowers, but relatively few people or businesses wish to borrow. As a result, some credit card firms will lower the interest rates (or other fees) they charge to attract more business. This strategy will push the interest rate down toward the equilibrium level. If the interest rate is below the equilibrium, then excess demand or a shortage of funds occurs in this market. At an interest rate of 13%, the quantity of funds credit card borrowers demand increases to $700 billion, but the quantity credit card firms are willing to supply is only $510 billion. In this situation, credit card firms will perceive that they are overloaded with eager borrowers and conclude that they have an opportunity to raise interest rates or fees. The interest rate will face economic pressures to creep up toward the equilibrium level. The FRED database publishes some two dozen measures of interest rates, including interest rates on credit cards, automobile loans, personal loans, mortgage loans, and more. You can find these at the FRED website (https://openstax.org/l/FRED_stlouis). Shifts in Demand and Supply in Financial Markets Those who supply financial capital face two broad decisions: how much to save, and how to divide up their savings among different forms of financial investments. We will discuss each of these in turn. Participants in financial markets must decide when they prefer to consume goods: now or in the future. 98 4 • Labor and Financial Markets Access for free at openstax.org
eBook - PDF- Steven A. Greenlaw, Timothy Taylor(Authors)
- 2015(Publication Date)
- Openstax(Publisher)
The equilibrium occurs at an interest rate of 15%, where the quantity of funds demanded and the quantity supplied are equal at an equilibrium quantity of $600 billion. If the interest rate (remember, this measures the “price” in the financial market) is above the equilibrium level, then an excess supply, or a surplus, of financial capital will arise in this market. For example, at an interest rate of 21%, the quantity of funds supplied increases to $750 billion, while the quantity demanded decreases to $480 billion. At this above-equilibrium interest rate, firms are eager to supply loans to credit card borrowers, but relatively few people or businesses wish to borrow. As a result, some credit card firms will lower the interest rates (or other fees) they charge to attract more business. This strategy will push the interest rate down toward the equilibrium level. If the interest rate is below the equilibrium, then excess demand or a shortage of funds occurs in this market. At an interest rate of 13%, the quantity of funds credit card borrowers demand increases to $700 billion; but the quantity credit card firms are willing to supply is only $510 billion. In this situation, credit card firms will perceive that they are overloaded with eager borrowers and conclude that they have an opportunity to raise interest rates or fees. The interest rate will face economic pressures to creep up toward the equilibrium level. Shifts in Demand and Supply in Financial Markets Those who supply financial capital face two broad decisions: how much to save, and how to divide up their savings among different forms of financial investments. We will discuss each of these in turn. Participants in financial markets must decide when they prefer to consume goods: now or in the future. Economists call this intertemporal decision making because it involves decisions across time.
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