3. Supply and demand for loanable funds

The following graph shows the market for loanable fundsin a closed economy. The upward-sloping orange line represents the supply of loanable funds, and the downward-sloping blue line represents the demand for loanable funds.

01002003004005006007008009001000110012001211109876543210INTEREST RATE (Percent)LOANABLE FUNDS (Billions of dollars)DemandSupply

is the source of the demand for loanable funds. As the interest rate falls, the quantity of loanable funds demanded .

Suppose the interest rate is 5.5%. Based on the previous graph, the quantity of loanable funds supplied is than the quantity of loans demanded, resulting in a of loanable funds. This would encourage lenders to the interest rates they charge, thereby the quantity of loanable funds supplied and the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of

.