Equilibrium in the Market for Loanable Funds

The market for loanable funds occurs when suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers). Trading in the market for loanable funds determines the equilibrium interest rate.

Now that we have covered the supply of savings and the demand to borrow, we can put them together to find an equilibrium in what economists call the market for loanable funds. In Figure 9.6, the equilibrium interest rate is 8% and the equilibrium quantity of savings is $250 billion. Notice that in equilibrium, the quantity of funds supplied equals the quantity of funds demanded.

Equilibrium in the Market for Loanable Funds Determines the Interest Rate and the Quantity of Loanable Funds At an interest rate greater than 8%, there is a surplus of savings and the interest rate is bid down. At an interest rate less than 8%, there is a shortage of savings and the interest rate is bid up. At an interest rate of 8%, the quantity of savings supplied ($250 billion) is exactly equal to the quantity of savings demanded.

The interest rate adjusts to equalize savings and borrowing in the same way and for the same reasons that the price of oil adjusts to balance the supply and demand for oil. If the interest rate were higher than 8%, the quantity of savings supplied would exceed the quantity of savings demanded, creating a surplus of savings. With a surplus of savings, suppliers will bid the interest rate down as they compete to lend. If the interest rate were lower than 8%, the quantity of savings demanded would exceed the quantity of savings supplied, a shortage. With a shortage of savings, demanders would bid the interest rate up as they competed to borrow. (See Chapter 4 for a review.)