1. The Market for Loanable Funds Supply = Demand

2. Loanable Funds Demand Curve: Slope Demand for loanable funds, D The loanable funds demand curve is downward sloping. Why? Interest rate, r Quantity of loanable funds

3. Loanable Funds Supply Curve: Slope Interest rate, r Quantity of loanable funds Supply of loanable funds, S The loanable funds supply curve is upward sloping. Why?

4. Shifts of the Loanable Funds Demand Curve 1.Changes in Perceived Business Opportunities a.Think changes about beliefs in “rate of return” 2.Changes in the Government’s Borrowing a.“Crowding Out”

5. Shifts of the Loanable Funds Supply Curve 1.Changes in Private Savings Behavior a.What would make you save more? Less? 2.Changes in Capital Inflows a.Is your country a “good investment”?

6. E Equilibrium Loanable Funds Demand curve, D Loanable Funds Supply curve, S Equilibrium in the Loanable Funds Market Interest rate, r Quantity of loanable funds rErE QEQE

7. Loanable Funds Demand Curve: Shifts in the Curve Right shift of the demand for loanable funds curve… D2D2 D1D1 Interest rate, r Quantity of loanable funds r2r2 r1r1 Supply of loanable funds, S …causes an increase in the interest rate.

8. Loanable Funds Supply Curve: Shifts in the Curve Right shift of the supply for loanable funds curve… D1D1 Interest rate, r Quantity of loanable funds r2r2 r1r1 Supply of loanable funds, S S2S2 …causes a decrease in the interest rate.

9. M2M2 E1E1 Interest rate, r Quantity of loanable funds Quantity of money Interest rate, r r2r2 r1r1 MS 1 MS 2 E2E2 r1r1 D E1E1 M1M1 MD 1 Q1Q1 r2r2 E2E2 Q2Q2 S1S1 S2S2 The Fed increases the money supply… Short-Run Determination of the Interest Rate …which lowers the interest rate… …and leads to a short-run increase in GDP and an increase in the supply of loanable funds. The Liquidity Preference Model of the Interest RateThe Loanable Funds Model of the Interest Rate

10. M2M2 E1E1 Interest rate, r Quantity of loanable funds Quantity of money Interest rate, r r2r2 r1r1 MS 1 MS 2 E2E2 r1r1 D E1E1 M1M1 MD 1 Q1Q1 r2r2 E2E2 Q2Q2 S1S1 S2S2 In the long run, the rise in the price level shifts the money demand curve to the right… Long-Run Determination of the Interest Rate …which raises the interest rate back to the original level… …which reduces real GDP and the supply of loanable funds until aggregate output equals potential output. The Liquidity Preference Model of the Interest RateThe Loanable Funds Model of the Interest Rate MD 2 E3E3