Answer to Question #233920 in Macroeconomics for fely

Question

Discuss the loanable funds theory and interest rates (12marks)

Answer 1

Solution:

According to the loanable fund's theory, the interest rate is determined by the demand for and supply of loanable funds. The supply of loanable funds represents the behavior of all the savers in a particular economy. The higher the interest rate that a saver can earn, the more likely they are to save money. Therefore, the supply of loanable funds shows that the quantity of savings will increase as the interest rate increases.

According to this theory, the equilibrium rate of interest is determined at the point where demand and supply of loanable funds intersect, that is where they are equal. Therefore, the rate of interest is determined by the equilibrium between the level of saving and the level of investment.