Question

3. Supply and demand for loanable funds 

The following graph shows the market for loanable funds in a closed economy. The upward-sloping orange line represents the supply of loanable funds, and the downward-sloping blue line represents the demand for loanable funds.

Investment is the source of the supply of loanable funds. 

As the interest rate falls, the quantity of loanable funds supplied increases.

 Suppose the interest rate is 7%. In this case, the quantity of loanable funds supplied is greater than the quantity of loans demanded, resulting in a srplus of loanable funds. This would encourage lenders tolower the interest rates they charge, thereby decreasing the quantity of loanable funds supplied and increasing the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of 3%

Answer 1

In the market for loanable funds, it is the savings which is the source of supply of loanable funds.

This indicates that as the rate of interest falls, the quantity of loanable funds supplied decreases because the supply curve is upward sloping.

Interest rate is at 7%. This is greater than the market interest rate of 5% so at this interest rate, the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded.

This results in a surplus of funds. This encourages lenders to lower the rate of interest which decreases the quantity of loanable funds supplied and increases the quantity of loanable funds demanded.

The market equilibrium rate of interest is 5%.