Loanable Funds Market Graph – Demand, Supply, Equilibrium, Shifts

Loanable funds market graph illustrates how the demand and supply of loanable funds decide the equilibrium. First of all, let’s consider that “what is loanable funds market?”

Loanable funds market explained

The loanable funds market is best described as bringing together how funds servers and money borrowers are interacted. Here interest rates determine how funds are demanded and supplied.

Here are the key terms of loanable funds market that we should understand.

Participants:

There are two main types of participants in a loanable funds market. They are, savers and borrowers.

Savers: Savers supply the loanable funds. They can be individuals or organizations who choose to save money instead of money spending. Savings accounts kept by individuals, retained earnings by companies, and even budget surpluses by governments are a few examples for savers.

Borrowers: Savers demand the loanable funds. They can be individuals or organizations who to lend money. We may give the following as examples: companies borrowing money for investments, individuals financing home loans or auto purchases, or governments issuing bonds to finance infrastructure projects.

Financial instruments:

Savers deposit their funds in various financial instruments like bonds, CDs, or savings accounts.

Borrowers borrow money funds in different types of financial instruments including the loans and bonds.

Interest Rate:

Interest rate can be considered as the price of the loanable funds market. At the equilibrium interest rate, demand and supply of the loanable funds are equal to each other.

Supply of loanable funds

Supply of loanable funds can be defined as the aggregate amount of funds that lenders in other words savers are able to lend at a given interest rate.

If not loanable funds supply presents the individuals and business organizations ability of postpone current consumption and dedicate a portion of their income to savings for future use.

There is a positive relationship between interest rate and loanable funds supply. That means, when interest rates become high, lenders save more funds since they are offered a higher return on benefit.  However, the relationship between interest rate and loanable funds supply is not linear. Because there is a diminishing marginal return.

Demand of loanable funds

Demand of loanable funds can be defined as the aggregate amount of funds that borrowers in other words investors wish to borrow at given interest rate.

In other words, demand for loanable funds present the expectations of the business organizations and individuals to access the external funding sources at their different requirements.

There is a negative relationship between interest rate and loanable funds demand. That means, when interest rates become high, borrowers borrow less funds since they have to bear high cost of borrowing.

Now you can understand how demand and supply forces of the loanable funds market change according to the interest rate. Now, let’s draw a loanable funds market graph to illustrate the interaction between demand and supply of loanable fuds market.

Loanable funds market graph

How to draw a loanable funds market graph? Graph of loanable funds market can graph as follows.

According to the above graph of loanable funds market, loanable funds market also same to the market for a normal good. Here interest rate work as the price for the loanable funds. So, there is a negative relationship between interest rate and loanable funds demand. There is a positive relationship between interest rate and loanable funds supply. Equilibrium in the loanable funds market determines interest rate that borrowers and savers agree to pay and receive.

Loanable funds market graph at equilibrium

Loanable funds market equilibrium is the situation that demand for loanable funds and supply for loanable funds equals to each other. According to above loanable funds market graph, at the point E1, both demand and supply are equals to each other and so that, it is the loanable funds market equilibrium.

Loanable funds market graph shifters

Loanable funds market shifters means any factor that alters the equilibrium of the loan market. They can be either shift supply or demand curve of the loanable funds.

What causes shifts in the loanable funds market? Loanable funds market graph shifts can be divided into two categories. They are demand-side shifters and supply-side shifters. Let’s consider about them.

Shifters of Supply

Changes in Saving: One of the main shifts that cause to change the supply of loanable funds is savings. Savings by the lenders (savers) can be raised as results of the higher income level more preference to save funds and so on. When saving is rising, it leads to rightward shifts of the loanable supply and decrease of the equilibrium interest rate.

Government Borrowing: Government borrowings can be considered as a substitute good for a loanable funds. When government borrows more, lenders can lend their money to government other than lending to investors. This can shifts the supply curve to the leftward.

Financial Intermediation: The supply curve may also be impacted by modifications in how well financial institutions transfer savings to lenders. A reduction in interest rates can occur from a rightward shift in the curve caused by improved efficiency.

Shifters of Demand

Investment Opportunities: If there are new or attractive investment opportunities are available for the investors, they require more loanable funds. This cause to rightward shift of the demand curve of loanable funds. On the other hand, if investors lose their investment opportunities, they decrease the demand for loanable funds

Expected Return on Investment: If borrowers can expect higher returns on investment, they invest more. For that, they require more loanable funds and so that, they rise the demand for loanable funds.

Borrower Confidence: Borrowers are more willing to take on debt when they have confidence in the economy and their capacity to pay it back, which could move the demand curve to the right and pull up interest rates. Alternatively, a low level of confidence causes the curve to move to the left, lowering the interest rate.

External Factors

Beyond the above-mentioned shifters of supply and demand, some external factors can impact either the supply or demand of loanable funds. Let’s discuss them.

Global Economic Conditions: Global economic conditions such as global wars, and recessions can impact domestic loanable funds markets. For example, when there is a global recession, the demand and supply of loanable funds shift to the left.

Technological Advancements: As a result of technological advancements, new investment opportunities can be generated. On the other hand, technology can disrupt some investments.