Transcript AP Macroeconomics

AP Macroeconomics
The Loanable Funds Market
Loanable Funds Market
• The market where savers and borrowers
exchange funds (QLF) at the real rate of interest
(r%).
Demand of Loanable Funds
• The demand for loanable funds, or
borrowing comes from households, firms,
government and the foreign sector.
• The demand for loanable funds is in fact the
supply of bonds.
• When you demand a loan, you are the
borrower.
• The person loaning you money is the lender
Demand for Loanable
Funds=Supply of Bonds
• If you are demanding a loan, you must
supply a bond.
• A bond is a debt instrument
• When you issue bonds you are supplying
bonds and you are demanding a loan
• So DLF=S of bonds
Supply of Loanable
Funds=Demand of Bonds
• If you loan someone money, wouldn’t
you like a receipt?
• If you loan someone money, you are
supplying a loan (SLF) and you are
demanding a bond (DLF)
• So demand of loanable funds is equal
to the supply of bonds
Supply of Loanable Funds
• The supply of loanable funds, or
savings comes from households, firms,
government and the foreign sector.
• The supply of loanable funds is also the
demand for bonds.
Loanable Funds Market in
Equilibrium
r%
SLF & DBonds
r
DLF & SBonds
q
QLF
Why Borrow Money
• Businesses want to hold cash in case of
unforeseen circumstances (opportunities
and emergencies)
• Some companies have cash overseas. If
they repatriate that money they owe US
Federal Tax on it.  for the company
• Ig is often an expensive proposition. Can
be more expensive than the cash the
company has
Changes in the Demand for
Loanable Funds
• Remember that demand for loanable funds =
borrowing (i.e. supplying bonds)
• More borrowing=more demand for loanable funds (D)
• Less borrowing = less demand for loanable funds (D)
Changes in the Demand for
Loanable Funds (cont.)
–Government deficit spending = more
borrowing= more demand for loanable
funds
.: DLF  .: r%↑
–Less investment demand = less
borrowing=less demand for loanable
funds
.: DLF .: r%↓
Increase in the Demand
for
Loanable
Funds
r%
SLF
r1
r
DLF
q
q1
DLF  .: r% ↑ & QLF ↑
QLF
DLF 1
Decrease in the Demand
for
Loanable
Funds
r%
SLF
r
r1
DLF 1
q1 q
DLF  .: r% ↓ & QLF ↓
QLF
DLF
Changes in the Supply of Loanable Funds
• Where does the supply of LF come from?
• The supply of loanable funds = savings
• Households, firms, governments and the foreign
sector save money (i.e. demand for bonds)
– Positive/negative feelings for an economy, attitude on future
of economy, MPC goes down savings probably goes up
• More saving = more supply of loanable funds()
• Less saving = less supply of loanable funds ()
Changes in the Supply of Loanable Funds
– Government budget surplus = more saving
= more supply of loanable funds
.: SLF  .: r%↓
– Decrease in consumers’ MPS = less saving
= less supply of loanable funds
.: SLF .: r%↑
Increase in the Supply
of
Loanable
Funds
r%
SLF
SLF 1
r
r1
DLF
q
q1
SLF  .: r% ↓ & QLF ↑
QLF
Decrease in the Supply of
Loanable
Funds
S
r%
LF 1
SLF
r1
r
DLF
q1
q
SLF  .: r% ↑ & QLF ↓
QLF
Final thoughts on Loanable Funds
• Loanable funds market determines the real
interest rate (r%).
• Loanable funds market relates saving and
borrowing.
• Changes in saving and borrowing create
changes in loanable funds and therefore the r%
changes.
Final thoughts on Loanable
Funds (cont.)
• When government does fiscal policy it
will affect the loanable funds market.
• Changes in the real interest rate (r%)
will affect Gross Private Investment
Effect of Expansionary Fiscal Policy
on Loanable Funds & Investment
SLF
r%
r%
r1
r
DLF 1
ID
DLF
q
q1
QLF
I1
I
G↑ and/or T↓ .: Government deficit spends .: DLF  .: r%↑ .: IG↓
(Crowding-Out Effect)
IG