Loanable funds market

The loanable funds market is a macroeconomic model that explains how real interest rates are determined by the interaction of saving and borrowing. In the model, the "good" being traded is money available for lending, its "price" is the real interest rate, and the market clears where the supply of savings equals the demand for borrowed funds.

The supply of loanable funds comes from savers — households, firms, and sometimes the government (when it runs a surplus) — and slopes upward: higher real interest rates make saving more rewarding, so more funds are supplied. The demand for loanable funds comes from borrowers, chiefly firms financing investment projects and governments financing deficits, and slopes downward: higher rates make borrowing more expensive, so less is demanded.

Shifts in either curve move the equilibrium real interest rate. If households become thriftier, supply shifts right and rates fall. If the government runs a larger budget deficit, demand for funds shifts right, raising rates and potentially crowding out private investment — a favorite exam scenario. Expectations of higher business profitability shift investment demand right, also pushing rates up.

The loanable funds market is a core AP Macroeconomics graph. Expect questions asking you to draw the market, shift the correct curve in response to a change in saving behavior, government deficits, or investment demand, and identify the new equilibrium real interest rate and quantity of funds. In an open economy, the model extends to include foreign inflows and outflows of capital.