Shifts in the Market for Loanable Funds: Videos & Practice Problems

The market for loanable funds is influenced by shifts in supply and demand, primarily driven by expectations of future profit, corporate tax rates, and government borrowing needs. An increase in expected profits or a decrease in corporate taxes raises demand, leading to higher interest rates and quantities. Conversely, a government deficit increases demand for funds. Supply shifts occur due to household savings incentives and government budget surpluses. Increased savings or favorable tax incentives raise supply, lowering interest rates. Understanding these dynamics is crucial for grasping macroeconomic principles and the business cycle.

Demand Shifts in the Market for Loanable Funds

So just like any other market that we've discussed with supply and demand, our market for loanable funds can shift the supply and demand just the same. Alright, let's see some of the things that can shift our demand and our supply in the market for Loanable Funds. So let's start here with the demand. What are things that can make the demand for loanable funds shift? Remember, the demand this is the firms wanting money, right? The firms want money to invest, but we're also going to discuss the idea that the government also might need loanable funds, right? If the government is in a deficit position, they might need funds to borrow as well. So let's think about things that can shift the demand, okay? So let's start here with our first one. The firm's change in expectations of future profit. Okay, so if all of a sudden something happens that changes the expectations of future profits well, that's going to change the demand, right? If they think they can make more money in the future, well, they're going to want to invest more right now. If they think that the outlook of the future looks grim, they might invest less, right? So an idea here is an increase in available technology, right? If let's say the internet just suddenly got invented, well that creates a whole bunch of new opportunities, right? So we'll say here increase expectations on this graph and this will be decreased expectations of profit. Right? We're thinking about profit in the future. So if there's an increased expectation of profit, well guess what? There's going to be an increase in demand. So we've got our supply curve here, our demand curve, downward demand, and we'll have this new demand curve out here. And what's gonna happen in that case? If this was our original, we'll use our little devices here. So our new equilibrium is up there. So what do we have? We had our rate 1, remember this is interest rates here, And this is going to be the quantity of funds. Well, rate 1 and quantity 1. So we're going to have an increase in the rate and an increase in the quantity, right? To rate 2 and quantity 2. Both of them are going to increase with this increase in demand. Just like we saw before when we first studied supply and demand. Now the opposite if there's a decrease in expectations, right? I'll put R here. R, q, right? So in this case, we're gonna have a decrease in demand and that would be this way, right? We're gonna shift the demand this way. So this being our original equilibrium, our new equilibrium, well guess what? The opposite's gonna happen here. Right? We're going to have r1q1 and we're gonna have a decrease. A decrease to R2 and a decrease to Q2. Right? And that's the decrease in expectations. So it's whether it's a good thing or a bad thing for demand, right? Does it is it gonna increase demand? Increase expectation of profit? Well, we wanna make more investments, right? So let's go on to the next one here. So the next one is a change in corporate tax rates. So this is going to affect firms as well, right? If there's a change in the tax rates, So what do you think is going to happen if there's increased taxes? In the case of increased taxes and this one will do decrease taxes, well, if there's more tax, that's bad for the firms. Right? They have more costs now and they're going to be less likely to invest. So if this was our original equilibrium here, if taxes went up, well, our demand for loanable funds would go down, right? They have more cost to cover now with increased taxes, and we're gonna have this decrease in our demand for loanable funds leading to a decreased interest equilibrium and a decreased quantity as well. Okay? Just like we're used to with supply and demand and obviously, we'll see the opposite here with a decrease in taxes. Now, they have more money available. There's a decrease in their taxes. They have more reason to invest, right? They see basically a better outlook in the future with lower taxes. They can make more money because they'll have to pay less taxes on it. Cool? So now in this case, we have the opposite effect. Supply, demand, where we have an increase to our rate. Our equilibrium rate goes up. The quantity demanded goes up because of these changes in corporate taxes. Cool. You see everything there? Let's do one more on the next page. It's our last shift in demand and that's due to government. This is the government change in government's needs for funds. So the idea here is if the budget if the government basically running a deficit, they need funds to cover their deficit. Whereas, if they're running a surplus, they're not gonna need funds. Don't need funds. Right? So most of the time when we think about the government, we're thinking about the savings, right? The government has a part in the national savings. They're the public savings here. But there is an effect that the government has on the demand for funds when they do need them. Right? So if they need funds, well if they're running a deficit, guess what? They're gonna shift the demand to the right because there's now more of a need for funds, and we'll end up here in this situation up here. So we'll see our rate having increased and our quantity demanded increased as well. Our equilibrium is going to increase as well. Right? Just like we see there at our new equilibrium and the opposite here when they don't need funds, well, that's gonna decrease the demand there. So once they move, from a place of needing funds and now they don't need funds, well, we'll have this decrease here. We will move to our new equilibrium down here. So this being our original equilibrium, now we move to a new equilibrium with a lower rate and a lower quantity demanded. Cool? So, little flashbacks here to earlier lessons, right? Where we were talking about supply and demand, well this is a macroeconomic application of it here. Cool? Alright, let's pause here and let's do a practice problem related to these shifts.

The scientists at University of Coloralabaska have discovered an insanely efficient teleportation device useful that revolutionized the shipping and delivery industry. How would this invention affect the market for loanable funds?

• A. Demand for loanable funds would increase, leading to a higher equilibrium interest rate
• B. Demand for loanable funds would increase, leading to a lower equilibrium interest rate
• C. Demand for loanable funds would decrease, leading to a higher equilibrium interest rate
• D. Demand for loanable funds would decrease, leading to a lower equilibrium interest rate

Answer: (A)

Supply Shifts in the Market for Loanable Funds

So now, let's see what things will shift the supply in the market for Loanable Funds. Okay? So remember, the supply comes from savings. Specifically, the savings of the households and the savings of the government. And remember, we called these, private savings and public savings. The savings of the government. So guess what? It’s going to shift either from the household savings or the government savings. So let's start with the households. There could be a change in the incentives for households to save. So an example would be tax benefits from a 401(k)s, right? So if those incentives increase, if there’s some reason that the government might give them more reason to save such as, oh, you can get tax breaks for saving. Well, that is going to increase the supply of loanable funds. So I’ll say, increased incentives and that would generally come in the form of tax breaks, incentives, and decreased incentives over here. Now remember, just like when we studied supply and demand, a change in the interest rate alone would only move us along the curve, right? It would only move us along the curve because interest is the price in this market. So if you remember when we discuss supply and demand, you might even want to go back, just a change in the price itself is not going to shift the curves. It won't shift the supply or demand, it just moves us along the curves. So the interest rate itself, being the price in this market, would only move us along the curve. There has to be some outside factor such as an increased incentive to save that would lead us to have a greater supply. Cool? So that's exactly what's going on here. So if there’s increased incentives, there’s going to be increased supply. So there would be a supply out here, leading us to S2, and what would happen in this market? Well, if we increase the supply, our equilibrium rate was originally here or equilibrium quantity here and now we’re out here. Right? We have this new equilibrium at this lower rate, R2 and we’ll have a greater quantity available, right? Because there’s more savings happening, there’s increased incentive to save, so there’s more savings happening lowering the interest rate and increasing the quantity available. Now, what about if we decrease the incentives? The opposite would happen, right? So now there’s less tax breaks that you get for saving. Well, people might save less leading us to have a decrease in supply and what’s going to happen in this case? So, a decreased supply, well, our new equilibrium is here. So since there’s a decreased supply, well, that’s going to increase the price of what is available. Right? And we will have a lower quantity available because of the decreased. We’ve got this increased rate and we’ve got this decreased quantity. Right? Equilibrium quantity there. Cool? So that's the household’s incentives. It comes from the incentive to save. How about the government? Well, it goes back to that idea of the government trade excuse me, budget surplus or budget deficit. So remember that the government’s going to have a surplus when they bring in tax revenue and they don't spend all of it. So the tax revenue is greater than its spending, right? Compared to the deficit which is the opposite is where they don’t have enough tax revenue to cover the spending is less than spending, right? Tax revenue is less than spending. So what is that public savings? Recall that that’s the amount of tax revenue left after the government has paid for its spending. So only in the case of a surplus would we have a situation where we actually have public savings, right? Because in a deficit, well, the tax revenue didn’t cover the government purchases. So if the government is running a budget deficit, it is not contributing to national savings, right? Because they are essentially borrowing money. So if those savings are not in the supply, right? Savings, remember that’s the supply of loanable funds comes from savings. Be it private or public. So in the case, we'll say no public savings because they're in a deficit or, yes, public savings because they're in a surplus situation. Right? So we’ll say that here too. Deficit surplus. Right? So what happens if there’s no public savings? Well, that’s going to lower our supply, Right? Just like before, we’re going to have a lower_supply because there’s not as much available. Our original equilibrium here, our new equilibrium here and that’s going to affect our rate and quantity. So rate 1 quantity 1. And we would have this higher interest rate because there’s a lower supply and less quantity available, right? The quantity exchange would be less at this higher interest rate. So in the case of a surplus, well that would increase our savings. Right? That would increase the available savings and increase the supply in this case. So just like we’re used to, we find our equilibrium rate, our equilibrium quantity, and then how it changed. So notice when there’s more savings available, the supply went up, the rate went down, and the quantity went up there. Let me get out of the way so you see the whole graph. Cool. So that’s exactly what happens in the other SVG. So basically, in the first graph, we’re talking about the private savings of the households. In these graphs, we’re talking about the public savings of the government. Cool? So that's about it. Those are all the that will shift the supply curve is things that will shift our supply, our private savings and our public savings. Alright, that's about it here. Let’s go ahead and move on to the next video.

Here’s what students ask on this topic:

What factors can shift the demand for loanable funds?

The demand for loanable funds can shift due to several factors. One primary factor is the change in firms' expectations of future profits. If firms expect higher future profits, they are more likely to invest now, increasing the demand for loanable funds. Conversely, if they expect lower future profits, the demand decreases. Another factor is corporate tax rates; higher taxes reduce firms' ability to invest, decreasing demand, while lower taxes increase it. Additionally, government borrowing needs can shift demand. If the government runs a deficit, it needs to borrow more, increasing demand for loanable funds. Conversely, a surplus reduces the need for borrowing, decreasing demand.

How do changes in household savings incentives affect the supply of loanable funds?

Changes in household savings incentives significantly impact the supply of loanable funds. If the government offers tax benefits or other incentives for saving, households are more likely to save, increasing the supply of loanable funds. This increased supply typically leads to a lower equilibrium interest rate and a higher quantity of funds available. Conversely, if these incentives are reduced or removed, households may save less, decreasing the supply of loanable funds. This reduction in supply results in a higher equilibrium interest rate and a lower quantity of funds available.

What is the impact of government budget deficits on the market for loanable funds?

Government budget deficits impact the market for loanable funds by increasing the demand for funds. When the government runs a deficit, it needs to borrow money to cover its spending, which shifts the demand curve for loanable funds to the right. This increased demand leads to a higher equilibrium interest rate and a higher quantity of loanable funds. Conversely, if the government runs a surplus, it does not need to borrow, which can decrease the demand for loanable funds, leading to a lower equilibrium interest rate and a lower quantity of funds.

How do corporate tax rates influence the demand for loanable funds?

Corporate tax rates influence the demand for loanable funds by affecting firms' investment decisions. Higher corporate tax rates increase the cost of investment for firms, reducing their ability to invest and thus decreasing the demand for loanable funds. This shift results in a lower equilibrium interest rate and a lower quantity of funds. Conversely, lower corporate tax rates reduce the cost of investment, encouraging firms to invest more, which increases the demand for loanable funds. This increased demand leads to a higher equilibrium interest rate and a higher quantity of funds available.

What role do government budget surpluses play in the supply of loanable funds?

Government budget surpluses play a crucial role in the supply of loanable funds. When the government runs a surplus, it means that its tax revenue exceeds its spending, contributing to public savings. This increase in public savings adds to the overall supply of loanable funds, shifting the supply curve to the right. As a result, the equilibrium interest rate decreases, and the quantity of loanable funds available increases. Conversely, if the government runs a deficit, it does not contribute to public savings, reducing the supply of loanable funds and leading to a higher equilibrium interest rate and a lower quantity of funds.