Question

Under the loanable funds theory, the equilibrium interest rate is determined by the interaction between the demand for and the supply of funds from financial market participants, mainly the household sector, the business sector and the government sector

Explain why the household sector, the business sector and the government sector borrow and demand loanable funds. Provide two reasons for each of these sectors.

Answer 1

The houehold sector demand loanable funds for purchasing different types of goods/ meeting their expenses. They also require funds to make investments in businesses.

Business sector demands loanable funds for investing in different projects. They borrow to be able to use the funs in their business. They may also demand loanable funds to pay off their other liabilities.

The Government sector borrows money to be able to pay off their other debts. The Government also borrows funds when its does not have sufficient revenue to pay its expenses.