Briefly explain the loan able funds theory of interest rate determination
What will be an ideal response?
The demand for loan able funds shows the inverse relationship between the interest rate and the quantity of loan able funds demanded. At lower interest rates, more loan able funds will be demanded than at higher interest rates. The demand for loan able funds is a function of the demand for loans expressed by different groups in the economy—consumers, businesses, and governmental institutions. These groups borrow more when the interest rate is low because it is less expensive to borrow money. The supply of loan able funds shows a positive relationship between the interest rate and the quantity of loan able funds supplied. The higher the interest rate, the more incentive households will have to supply loan able funds to financial institutions. Consumers are more willing to forego consumption. When graphed, the demand for loan able funds is a down sloping curve, and the supply of loan able funds is an up sloping curve. The intersection of the supply curve and the demand curve for loan able funds determines the rate of interest.
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