1. The Market for Loanable Funds Chapter 13

2. The Market for Loanable Funds Financial markets coordinate the economy’s saving and investment in the market for loanable funds. Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.

3. The Supply and Demand of Loanable Funds The supply of loanable funds comes from people who have extra income they want to save and lend out (savings). The demand for loanable funds comes from households and firms that wish to borrow to make investments (borrowing).

4. Loanable Funds (in billions of dollars) 0 Real Interest Rate Demand (borrowing) Supply (savings) 4% $1,000 Market for Loanable Funds...

5. The interest rate is the price of the loan. It represents the amount that borrowers pay for loans and the amount that lenders (savers) receive on their saving. As interest rates rise savers (suppliers) will be more willing to save and vice versa. As interest rates fall borrowers (demanders) will be more willing to borrow and vice versa. Supply and Demand for Loanable Funds

6. Market for Loanable Funds Real Interest RatesQuantity of loanable funds supplied Quantity of loanable funds demanded 6%1400600 5%1200800 4%1000 3%8001200 2%6001400

7. Taxes and Saving Taxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save (supply curve shifts left). The result will be higher interest rates and smaller investment. If a change in tax law encourages greater saving (supply curve shifts right), the result will be lower interest rates and greater investment.

8. S2S2 1. Households decide to save more of their income. An Increase in the Supply of Loanable Funds... Loanable Funds (in billions of dollars) 0 Interest Rate 4% Supply, S 1 $1,000 Demand $1,200 3....and raises the equilibrium quantity of loanable funds. 3% 2....which reduces the equilibrium interest rate... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

9. Taxes and Investment A change in tax laws can encourage greater investment (a reduction in the capital gains tax). This would shift the demand curve right and the result will be higher interest rates and greater saving.

10. An Increase in the Demand for Loanable Funds... Loanable Funds (in billions of dollars) 0 Interest Rate 5% $1,200 Supply Demand, D 1 1. An investment tax credit increases the demand for loanable funds... D2D2 6% 2....which raises the equilibrium interest rate... $1,400 3....and raises the equilibrium quantity of loanable funds. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

11. Government Budget Deficits and Surpluses Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms. Interest rates rise and investment falls. This fall in investment is referred to as crowding out. u The deficit borrowing crowds out private borrowers who are trying to finance investments.

12. S2S2 1. A budget deficit decreases the supply of loanable funds... The Effect of a Government Budget Deficit... Loanable Funds (in billions of dollars) 0 Interest Rate $1,200 Supply, S 1 Demand 5% $800 3....and reduces the equilibrium quantity of loanable funds. 2....which raises the equilibrium interest rate... 6% Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.