Question

Explain how each of the following events would affect the supply of loanable funds curve:

1. The economy is in a recession, so people's disposable income is lower.

2. The stock market is booming so people's wealth is higher.

3. The future looks a bit grimmer, so expected future income is lower. The real interest rate increases.

Answer 1

1. If disposable income is lower, people will be able to save less. This is because people tend to stick to their usual level of consumption even when incomes decline which leads to decline in savings. Due to this, the supply of funds in the loanable funds market will decline.

2. If people's wealth is higher, people can save more. Accordingly, they will put more money in savings in the loanable market. This increases the supply of loanable funds in the market.

3. If the future looks grimmer for people, but the real interest rates are higher now, people expect a higher return in the present period as comoared to saving in the future period. Hence, people will save more now so that they can use this money in the future which is not looking good now.

Hence, the supply of loanable funds will rise in the present period.