Introduction to Loanable Funds Market

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Introduction to the Loanable Funds Market

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 funds framework, the supply represents the total amount that is being lent out at different interest rates or the amount being saved in the economy while the demand curve represents the total demand for borrowing at any given interest rate. Lending in the loanable funds framework takes many forms. Any time a person saves some of his or her income, that income becomes available for someone to borrow. Money saved in a bank savings account is part of the supply of loanable funds. If you deposit money in a bank rather than spending it, the bank can then lend the money to a person or business that wants to borrow. In this way you are supplying funds into the loanable funds framework (and the business or person borrowing the funds is contributing to the demand for loanable funds).

For example, if a person has an income of $20,000, spends $18,000 on goods and services and puts $2,000 into a savings account, the supply of loanable funds will increase by $2000. This $2000 is now available for someone else to borrow. The quantity of loanable funds supplied increases as the interest rate increases. When deciding on how much to save, an individual looks at the benefit that they can get by saving. As the interest rate increases, the benefit that you get through saving increases (higher interest earnings) and this tends to encourage people to save more. In general, as the interest rate increases, the quantity of loanable funds supplied (the aggregate willingness to save) will increase. This is why the supply curve in the loanable funds framework slopes upwards (in a graph with interest rates on the vertical axis and the quantity of loanable funds on the horizontal axis). For example, if you have an extra $5000 in your checking account and you see that interest rates are at...
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