The Loanable Funds Market
Jackson Hernandez
6 min read
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Study Guide Overview
This study guide covers the loanable funds market, focusing on the interaction between borrowers and savers. It explains the demand and supply of loanable funds, their relationship with the real interest rate, and factors that shift these curves (BIG DEE and FELS mnemonics). The guide also covers market equilibrium and the impact of shifts on the equilibrium real interest rate and quantity. Finally, it provides exam tips, including common question types, policy implications, and strategies for success.
Macroeconomics: Loanable Funds Market - Your Ultimate Study Guide 🚀
Hey there! Let's get you prepped and confident for your exam. This guide breaks down the loanable funds market into easy-to-digest sections, focusing on what you really need to know. Let's do this!
1. Introduction to the Loanable Funds Market
The loanable funds market is where borrowers (demanders of funds) and savers (suppliers of funds) interact. The real interest rate is the price that balances this market.
- Equilibrium: Occurs when the quantity of loanable funds demanded equals the quantity supplied.
2. Demand for Loanable Funds
2.1. Basics of Demand
The demand for loanable funds is inversely related to the real interest rate. Higher rates mean less borrowing; lower rates mean more borrowing.
- Inverse Relationship:
- ⬆️ Real Interest Rates ➡️ ⬇️ Quantity of Loanable Funds Demanded
- ⬇️ Real Interest Rates ➡️ ⬆️ Quantity of Loanable Funds Demanded
Demand curve for loanable funds. Note the inverse relationship between interest rate and quantity demanded.
2.2. Shifters of Demand
Remember BIG DEE to recall the shifters of demand for loanable funds: Borrowing, International, Government, Deficit, Expectations.
Factors that shift the demand curve for loanable funds.
- Borrowing, Lending, and Credit:
- ⬆️ Loans/Credit ➡️ ⬆️ Demand for Loanable Funds
- ⬇️ Loans/Credit ➡️ ⬇️ Demand for Loanable Funds
- Foreign Demand for Domestic Currency:
- ⬆️ Foreign Demand for Currency ➡️ ⬆️ Demand for Loanable Funds
- ⬇️ Foreign Demand for Currency ➡️ ⬇️ Demand for Loanable Funds
- Deficit Spending:
- ⬆️ Deficit Spending ➡️ ⬆️ Demand for Loanable Funds
- ⬇️ Deficit Spending ➡️ ⬇️ Demand for Loanable Funds
- Expectations for the Future:
- Positive Economic Outlook ➡️ ⬆️ Demand for Loanable Funds
- Negative Economic Outlook ➡️ ⬇️ Demand for Loanable Funds
3. Supply of Loanable Funds
3.1. Basics of Supply
The supply of loanable funds is directly related to the real interest rate. Higher rates mean more lending; lower rates mean less lending.
- Direct Relationship:
- ⬆️ Real Interest Rates ➡️ ⬆️ Quantity of Loanable Funds Supplied
- ⬇️ Real Interest Rates ➡️ ⬇️ Quantity of Loanable Funds Supplied
Supply curve for loanable funds. Note the direct relationship between interest rate and quantity supplied.
3.2. Shifters of Supply
Remember FELS to recall the shifters of supply for loanable funds: Foreign, Expectations, Lending, Savings.
Factors that shift the supply curve for loanable funds.
- Savings Rate:
- ⬆️ Savings ➡️ ⬆️ Supply of Loanable Funds
- ⬇️ Savings ➡️ ⬇️ Supply of Loanable Funds
- Expectations for the Future:
- Economic Contraction ➡️ ⬆️ Supply of Loanable Funds
- High Inflation Expectations ➡️ ⬇️ Supply of Loanable Funds
- Lending at the Discount Window:
- ⬇️ Discount Rate ➡️ ⬆️ Supply of Loanable Funds
- ⬆️ Discount Rate ➡️ ⬇️ Supply of Loanable Funds
- Foreign Purchases of Domestic Assets:
- ⬆️ Foreign Purchases ➡️ ⬆️ Supply of Loanable Funds
- ⬇️ Foreign Purchases ➡️ ⬇️ Supply of Loanable Funds
4. Loanable Funds Market Equilibrium
The intersection of the demand and supply curves determines the equilibrium real interest rate and the equilibrium quantity of loanable funds.
Equilibrium in the loanable funds market.
4.1. Shifts and Their Impact
- Demand Shifts:
- ⬆️ Demand ➡️ ⬆️ Real Interest Rate
- ⬇️ Demand ➡️ ⬇️ Real Interest Rate
- Supply Shifts:
- ⬆️ Supply ➡️ ⬇️ Real Interest Rate
- ⬇️ Supply ➡️ ⬆️ Real Interest Rate
Always draw the graph! Visualizing the shifts will help you understand the impact on the real interest rate and quantity of loanable funds.
5. Final Exam Focus
Key Topics: * Understanding the inverse relationship of demand and direct relationship of supply with real interest rates. * Identifying and applying the shifters of demand and supply. * Analyzing the impact of shifts on equilibrium.
5.1. Common Question Types
- Graphing: Be prepared to draw and shift the demand and supply curves.
- Scenario Analysis: Questions will often present a scenario and ask you to determine the impact on the market.
- Policy Implications: Understand how government policies (like deficit spending or changes in the discount rate) affect the market.
5.2. Last-Minute Tips
- Time Management: Don't spend too long on any one question. Move on and come back if needed.
- Common Pitfalls:
- Confusing demand and supply shifters.
- Forgetting the direction of the relationship between interest rates and quantity.
- Not drawing the graph to visualize the shifts.
- Strategies:
- Read each question carefully.
- Draw the graph first, then analyze the shifts.
- Use the mnemonics (BIG DEE and FELS) to remember the shifters.
Remember, the real interest rate is the price of borrowing money. It's what balances the market.
Don't confuse nominal and real interest rates. The loanable funds market uses the real interest rate (nominal rate minus inflation).
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