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The rate of interest is determined by the relationship between supply and demand in the market for loanable funds. An economy will have a stock of loanable funds held in banks and other financial institutions. These funds can be borrowed by firms for investment. When people save, they build up the supply of loanable funds. This flow of saving represents the resources released when people refrain from consumption. The amount people are willing to save depends on the rate of interest. The supply curve will be relatively inelastic in the short run, since the flow of saving over a short time period i.e. a month will have only a relatively small effect on the total stock of funds. The longer the period, the more elastic the supply curve. The amount saved also depends on the level of people’s incomes, their expectation of future price changes, and their willingness to forgo present consumption in order to be able to have more in the future. A change in these determinants of supply will shift the supply curve.
Approximate Word count = 661
Approximate Pages = 2.6
(250 words per page double spaced)
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