Question

Interest Rate SAQ, QO Quantity of Loanable Funds Refer to the market for loanable funds, as shown in the above graph. Suppose the market for loanable funds is originally in equilibrium at interest rate lo and quantity 20. In the next period, the equilibrium interest rate increases to ly and quantity decreases to Q1. Which of the following could be the cause of this shift? Investors become more optimistic Households decide to save more Households decide to save less Investors become less optimistic

Answer 1

Demand for loanable funds if by firms for investment purposes and by government for making the expenditure , for increasing the deficit.

Supply of loanable funds is by households in the form of savings.

In case investors are more optimistic , then they would increase the demand for loanable funds to make more investments and hence the demand curve will shift to the right. To maintain equilibrium , interest rate and quantity of loanable funds will both increase.

Opposite is the case when investors are less optimistic. Demand curve will shift to the left and the interest rate as well as the quantity of loanable funds will go down.

This can be seen from the diagram below :

interest Rath Vi og mvestors V on au more optimistic T100,00 Quantity of investors are less optimistic

If households save more ,then the supply of loanable funds curve will shift to the right. Because of Increase in the supply at the Equilibrium level, interest rate will have to go down and quantity of loanable funds will have to increase to restore the equilibrium.

​​​​​​If households save less, the supply curve will shift to the left. At the Equilibrium level there's is more demand of loanable funds than supply. Therefore interest rate will increase and quantity of loanable funds in the market will go down. Hence third option is the correct option.

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