1. They each earn income (Y);
they each spend and consume (C );
they each save (S).

2. Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $1,100 $1,000 $200
In a wholly Private Economy, Saving and Investment are Brought into Balance with an Interest Rate of, say, 5%.
Bob
Carol
Ted
Alice
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$1,100
$1,000 5%
$200
$400
$300
-$100
Rate of
Interest S 5% D
Loanable
Funds
$800
Net Saving by Bob, Carol, Ted, and Alice is $800.
Borrowing and Investing by the Business Community is $800.

3. Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $700 $1,100 $1,000
Suppose that, with the Interest Rate Still at 5%,
Bob and Carol decide they’d like to save more.
Bob
Carol
Ted
Alice
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$700
$1,100
$1,000 5%
$200
$300
$400
$500
-$100
Rate of
Interest S S
surplus 5% D
Loanable
Funds
$800
$1,000
Now, net Saving by Bob, Carol, Ted, and Alice is $1,000.
But Borrowing and Investing is still $800.

4. Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $700 $720 $1,100
With a Surplus of Loanable Funds, the Interest Rate falls to 3%,
So, Bob, Carol, Ted, and Alice all make adjustments.
Bob
Carol
Ted
Alice
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$700
$720
$1,100
$1,000
$1,030
$910 5% 3%
$200
$300
$280
$400
$500
$470
$290
-$100
-$130
Rate of
Interest S S
surplus 5% 3% D
Loanable
Funds
$800
$910
$1,000
Now, net Saving by Bob, Carol, Ted, and Alice is $910.
And Borrowing and Investing is also $910.

5. This is the market at work for you and for me.
Bob
Carol
Ted
Alice
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$700
$720
$1,100
$1,000
$1,030
$910 5% 3%
$200
$300
$280
$400
$500
$470
$290
-$100
-$130
This is the market at work for you and for me.
When people save more (i.e., when they consume less), the interest rate falls.
The business community responds by borrowing more funds and using them to expand the economy’s productive capacity.
Resources freed up by the reduced consumption are used for creating plant and equipment and engaging in longer-term production activities.
Saving also means increased buying power in the future---when the expanded investment activities have come to fruition.
Rate of
Interest S S 5% 3% D
Loanable
Funds
$800
$910
$1,000