Loanable funds market | Financial sector | AP Macroeconomics | Khan Academy

Summary

The video explains the market for loanable funds, where savers supply funds to be lent and borrowers demand funds to invest. The price in this market is the real interest rate. Supply and demand for loanable funds function similarly to other markets, with savers providing more funds at higher interest rates, and borrowers demanding more funds at lower rates. Shifts in demand can result from new business opportunities or government borrowing, while shifts in supply can occur if people save more. These shifts impact the equilibrium interest rate and quantity of loanable funds.

Takeaways

• 📊 The market for loanable funds involves the supply of funds (from savers) and the demand for funds (from borrowers).
• 💰 Savers are the suppliers in this market, offering their money to be lent out, often through intermediaries like banks.
• 📉 Borrowers create demand for loanable funds when they need capital for investments or business opportunities.
• 🏦 Banks serve as intermediaries by taking savers' deposits and lending them out, paying interest to savers and charging interest to borrowers.
• 📈 The real interest rate is the 'price' of loanable funds in this market, affecting both the supply from savers and the demand from borrowers.
• 🔺 As real interest rates rise, savers are more willing to supply funds, while borrowers demand fewer funds due to higher borrowing costs.
• 🔻 When real interest rates drop, demand for loans increases as borrowing becomes cheaper, while savers may supply fewer funds.
• 🚀 A shift in the demand curve for loanable funds can occur due to new business opportunities or increased government borrowing.
• 💼 If demand increases (e.g., new opportunities or government borrowing), the real interest rate rises to attract more loanable funds.
• 📉 A shift in the supply curve for loanable funds occurs if saving habits change, either increasing or decreasing the overall supply.

Q & A

What is the market for loanable funds?

The market for loanable funds refers to the market where funds that people are willing to supply to be lent out are matched with the funds that people want to borrow.

Who are the suppliers in the loanable funds market?

The suppliers in the loanable funds market are savers, who deposit money in banks or other financial institutions with the expectation of earning interest.

How do banks facilitate the loanable funds market?

Banks act as intermediaries in the loanable funds market by taking deposits from savers and lending those funds to borrowers, charging interest to the borrowers and paying interest to the savers.

Who are the demanders in the loanable funds market?

The demanders in the loanable funds market are borrowers, typically individuals or businesses looking to invest in opportunities or projects that require capital.

What is the role of interest rates in the loanable funds market?

Interest rates act as the price in the loanable funds market. They determine the cost of borrowing for demanders and the return on savings for suppliers.

What is the real interest rate and why is it important?

The real interest rate is the interest rate adjusted for inflation, which gives a more accurate representation of the real cost of borrowing or return on savings.

How does the supply of loanable funds respond to changes in real interest rates?

When real interest rates are higher, suppliers (savers) are more motivated to save, leading to an increase in the supply of loanable funds. Conversely, at lower real interest rates, the supply decreases.

What factors can cause a shift in the demand for loanable funds?

The demand for loanable funds can shift due to new business opportunities, increased government borrowing, or changes in the perceived attractiveness of investment projects.

What happens to the equilibrium in the loanable funds market when the demand curve shifts?

When the demand for loanable funds increases (shifts to the right), the equilibrium real interest rate rises and the quantity of loanable funds demanded also increases.

How might government policies affect the supply of loanable funds?

Government policies that encourage saving, such as marketing campaigns or educational initiatives, can increase the supply of loanable funds by shifting the supply curve to the right.

What is the effect on the loanable funds market if the savings rate decreases?

A decrease in the savings rate would shift the supply of loanable funds curve to the left, potentially leading to a higher real interest rate and a decrease in the quantity of loanable funds demanded at the new equilibrium.

Outlines

00:00

💡 Introduction to the Market for Loanable Funds

This section introduces the concept of markets for loanable funds. It explains that loanable funds refer to the money supplied by savers and demanded by borrowers. Savers supply funds through intermediaries like banks, which lend the money to borrowers, offering savers a return through interest. Borrowers typically seek loans for investments or business opportunities. The video emphasizes that this market operates similarly to other markets but with interest rates as the price, rather than a tangible good or service.

05:01

📊 Supply and Demand in the Loanable Funds Market

The second paragraph explores the supply and demand dynamics of the loanable funds market. The supply comes from savers who are more inclined to lend when interest rates are high, while demand comes from borrowers who prefer lower interest rates to fund their investments. The paragraph explains how the quantity of loanable funds and real interest rates interact, forming an equilibrium point where the amount supplied matches the demand at a specific interest rate.

📈 Shifts in Demand for Loanable Funds

Here, the focus shifts to how changes in the demand for loanable funds can affect the market. New business opportunities, such as asteroid mining, or increased government borrowing, can increase demand, shifting the demand curve to the right. This leads to a higher real interest rate and quantity of loanable funds at the new equilibrium. The paragraph also explores the opposite scenario, where decreased business opportunities or reduced government borrowing would lower demand and shift the curve left.

📉 Shifts in the Supply of Loanable Funds

This section discusses changes in the supply of loanable funds, such as when savings rates increase due to public awareness campaigns. When more people save, the supply curve shifts to the right, creating a surplus of loanable funds at the current interest rate. As a result, the real interest rate decreases, leading to a new equilibrium. Conversely, if fewer people save, the supply curve shifts left, causing the interest rate to rise. The paragraph highlights how supply shifts influence the market's equilibrium interest rate and quantity.

📌 Conclusion: Key Takeaways

The final paragraph summarizes the core ideas of the market for loanable funds. It reiterates that this market operates similarly to other markets, with the price being the real interest rate instead of a traditional good or service price. The importance of understanding supply and demand shifts in determining interest rates is emphasized, as is the need to factor in real interest rates to account for inflation.

Keywords

💡Market for loanable funds

The 'market for loanable funds' is a theoretical market where lenders and borrowers interact to determine the interest rate for loans. It's a concept used to understand how the supply of savings and the demand for borrowing interact to influence interest rates. In the video, this market is described as a place where savers (suppliers) provide funds to be lent out, and borrowers (demanders) seek these funds for various purposes like business investments. The video explains that this market operates through intermediaries, typically banks, which lend out savers' money and charge borrowers interest.

💡Savers

Savers are individuals or entities that supply funds to the market for loanable funds. They are typically people who deposit money in banks with the expectation of earning interest. In the video, it's mentioned that when savers save money, banks can lend that money out to others, and in return, the bank pays the savers some interest. Savers are depicted as the suppliers in the market for loanable funds and their behavior influences the supply curve of loanable funds.

💡Borrowers

Borrowers are individuals or entities that demand funds from the market for loanable funds. They are seeking to acquire funds to finance investments or other opportunities. The video explains that borrowers are interested in business opportunities and are willing to pay interest to acquire these funds. The demand for loanable funds comes from borrowers, and their willingness to borrow at certain interest rates shapes the demand curve.

💡Interest rate

The interest rate is the 'price' in the market for loanable funds. It represents the cost that borrowers pay to use the funds and the return that savers receive for providing their funds. The video emphasizes that the interest rate is a key determinant in the supply and demand dynamics of the market for loanable funds. It is the mechanism through which the market balances the desire to save with the desire to borrow.

💡Real interest rate

The real interest rate is the interest rate adjusted for inflation, which provides a more accurate reflection of the real cost of borrowing and the real return on savings. The video script explains that when considering the market for loanable funds, it's important to focus on the real interest rate rather than the nominal interest rate. This is because inflation can erode the value of money, so the real interest rate is what savers and borrowers actually care about.

💡Supply and demand

Supply and demand are fundamental economic concepts that describe the relationship between the availability of a product (or in this case, loanable funds) and the desire to acquire it. The video uses these concepts to explain how the market for loanable funds operates, with savers influencing the supply and borrowers influencing the demand. The interaction of these forces determines the equilibrium interest rate and quantity of loanable funds.

💡Equilibrium

Equilibrium in the context of the market for loanable funds refers to the point where the quantity of funds that savers are willing to supply equals the quantity that borrowers are willing to demand at a certain real interest rate. The video describes how shifts in the supply or demand curves can lead to a new equilibrium, where the interest rate adjusts to clear any surpluses or shortages of loanable funds.

💡Shifts in demand

Shifts in demand refer to changes in the quantity of loanable funds that borrowers are willing to demand at every possible interest rate. The video gives examples of how new business opportunities or increased government borrowing can shift the demand curve to the right, indicating an increase in demand. Conversely, a decrease in business opportunities or government borrowing would shift the demand curve to the left.

💡Shifts in supply

Shifts in supply refer to changes in the quantity of loanable funds that savers are willing to supply at every possible interest rate. The video suggests that factors such as changes in the savings rate due to marketing campaigns or educational efforts can shift the supply curve. An increase in the savings rate would shift the supply curve to the right, while a decrease would shift it to the left.

💡Surplus

A surplus in the market for loanable funds occurs when the quantity of funds supplied by savers exceeds the quantity demanded by borrowers at the current real interest rate. The video explains that a surplus would lead to a decrease in the real interest rate as the market seeks a new equilibrium where the quantity supplied equals the quantity demanded.

💡Shortage

A shortage in the market for loanable funds happens when the quantity of funds demanded by borrowers exceeds the quantity supplied by savers at the current real interest rate. The video indicates that a shortage would lead to an increase in the real interest rate as the market adjusts to encourage more saving and discourage borrowing until a new equilibrium is reached.

Highlights

The loanable funds market consists of the supply of savings and the demand for loans, which drives borrowing and lending activities.

Suppliers of loanable funds are typically savers, such as individuals who deposit money in banks, which can then be loaned to borrowers.

The price in the loanable funds market is the interest rate, more specifically, the real interest rate, which adjusts for inflation.

Higher real interest rates encourage more savings, increasing the supply of loanable funds, while lower rates reduce the incentive to save.

Borrowers are the demanders in the loanable funds market, often seeking funds for investment opportunities or business expansion.

As real interest rates rise, fewer borrowers are willing to take loans due to the higher cost of borrowing.

The market reaches an equilibrium where the supply of loanable funds meets the demand, establishing a balance between savers and borrowers.

A shift in demand for loanable funds can occur if new business opportunities arise, increasing the need for borrowing at any given interest rate.

Increased government borrowing can also shift the demand curve to the right, raising the overall demand for loanable funds.

When demand increases but the supply remains the same, a shortage of loanable funds develops, pushing up real interest rates to reach a new equilibrium.

A shift in the supply of loanable funds can result from higher savings rates, which increase the availability of funds for lending.

If supply increases but demand remains unchanged, there will be a surplus of loanable funds, leading to a decrease in the real interest rate.

A reduction in the supply of loanable funds or a drop in savings could cause the supply curve to shift left, increasing the real interest rate.

The loanable funds market behaves like other markets in terms of price (interest rate) adjustments, reflecting changes in supply and demand.

The real interest rate is used instead of the nominal rate to account for inflation, providing a clearer picture of the true cost of borrowing and the return on savings.

Transcripts

- [Instructor] We are used to thinking about markets

for goods and services,

and demand and supply of goods and services,

and what we're gonna do in this video is broaden our sense

of what a market could be for

by thinking about the market for loanable funds.

Now, this might seem like a very technical term,

loanable funds, but it literally just means funds

that people are supplying to be lent out to other people

and funds that people are demanding

that they want to borrow.

And so, one way to think about this market,

the suppliers in the loanable funds market,

these are the savers.

So, when you go and save some money, maybe at a bank,

that bank will then lend that money to someone else

and because the bank is getting interest from that person,

they can also afford to pay you some interest,

so you get a return.

It doesn't always have to be through a bank,

but that tends to be typical.

It will go through some type of intermediary.

Similarly, who are the demanders

or where's the demand coming from?

I don't know if demanders is a real word,

but I'll just write it down.

So, where is the demand coming from?

Well, that is coming from the borrowers

who are interested in, maybe, making an investment,

maybe some type of business opportunity

is available to them.

And as I mentioned, this isn't a market

where the suppliers and the demanders,

or the savers and the borrowers,

necessarily directly interact with each other.

Every now and then you might get a loan

from your sister-in-law or from your parents,

but oftentimes, usually, it's going through some type

of institution, some type of financial institution,

usually banks, where the savers put their money in a bank

hoping, not just for save keeping,

but really to get a return on their money.

In order to provide a return to those savers,

the bank will then lend it out to borrowers

and charge interest to them.

And to appreciate this in the way

that we've looked at markets before,

I can set up two axes

and in any market that we've looked at before,

the horizontal axis, this is the quantity,

and so here, we're talking about the quantity

of loanable funds,

loanable

funds.

And then on the vertical axis,

we normally think about the price

for the good or service,

but when we're dealing with loanable funds,

the price is the interest rate.

And if we want to know the real price,

we should be talking about the real interest rate.

Real

interest

rate.

And so, let's think about each of these scenarios.

Let's think about the savers

who are really the suppliers in the loanable funds market.

When real interest rates are lower,

if real interest rates are low,

they don't wanna really supply a lot of quantity.

They're not getting, not a lot of motivation

to be a supplier, to save in that situation.

But if real interest rates are high,

well, then they might say,

I'm more likely to save and I wanna make my funds available

for loaning out to other people

'cause I get this great interest rate,

especially when it's a real interest rate.

So, we could view it as something like this.

This we could call our supply of loanable funds

and you could imagine what the demand curve

for loanable funds looks like.

When real interest rates are high,

people say, hey, you know,

there aren't that many business opportunities

that could justify borrowing at that high of a rate,

so there wouldn't be much quantity that is demanded.

But as the real interest rates,

or if the real interest rates are lower, as they get lower,

then the quantity demanded of loanable funds will be higher.

So, this is our demand for loanable funds

and like we've seen in the past,

you're going to have an equilibrium quantity and price,

where price, in this situation,

is your real interest rate

and so that's going to happen where these intersect.

This is our equilibrium quantity

and this is our equilibrium real interest rate.

Now, let's think about what would happen if one

or both of these curves were to shift somehow.

And there's a couple of ways,

let's start with the demand for loanable funds.

There's a couple of ways that the demand

for loanable funds curve could shift.

Maybe all of a sudden people see new business opportunities.

Astroid mining is becoming a thing

and so people wanna borrow money to get robots

and send them out into space

so they can mine asteroids for platinum or something.

Well, what would happen?

Pause this video and think about that.

Well, then at any given real interest rate,

there's gonna be a higher quantity demanded.

So, in that situation, our demand

for loanable funds would shift to the right.

It would look something like this.

So, this is demand for loanable funds,

I'll call it sub two.

Sometimes you'll see something like a prime there,

but I'll call it sub two.

So, it has shifted to the right

because of new business opportunities.

Another common reason why that might shift

to the right is if maybe the government

is doing a lot more borrowing.

Remember, this is an aggregate market here.

So, the government, when it borrows money

to fuel its spending, that also,

it has to go into the loanable funds market

and so, increased government borrowing

would also shift this to the right.

And if the opposite happened,

if people thought there were fewer business opportunities

or if the government started to borrow less,

well, that would shift things to the left.

But let's just think about what would happen.

If R is the current equilibrium interest rate,

if that just stayed where it is,

well, then you're going to have a shortage

of loanable funds, where the suppliers would be willing

to supply this quantity while the borrowers are going

to want this quantity here at that real interest rate.

And so what you're going to have happen is

you're gonna get to a new equilibrium point.

The real interest rate is going to go up to this point,

let's call that our new equilibrium real interest rate,

and our quantity is going to go up as well, so Q1.

In order to convince more suppliers

to part with their money, not part with their money,

or at least make their money available for lending,

well, the interest rate's going to have to go up

and we get to that point right there.

Similarly, you could have shifts in the supply

of loanable funds.

Let's say, for example, the savings rate changes

for some reason.

There's a big marketing campaign from the government

or in education or in schools that say,

hey, we need to save more for a rainy day.

You need to save more for our retirement.

Well, then the supply of loanable funds,

if everyone saves more at any given real interest rate,

well, then the supply for loanable funds curve

could shift to the right,

and if the opposite happened,

of course it would shift to the left.

Supply of loanable funds two,

and then what would happen?

Well, if we were at this point right over here,

all of a sudden we are in a situation

where there's a surplus of loanable funds.

At this interest rate, people are willing

to supply way more loanable funds

than people are demanding,

so then the price of the loanable funds,

which is the real interest rate, will go down.

It will go down to this new equilibrium point,

and so here, this, we could call this R sub three

would be our new real interest rate,

equilibrium real interest rate,

and this would be our new equilibrium quantity.

Actually, let me call this R sub two right over here.

So, I will leave you there.

The big takeaway is that loanable funds kind

of operate the way the market for almost anything would

with the difference being that the price

is no longer just a dollar amount,

it is an interest rate

and since we wanna factor out inflation,

it is a real interest rate.