Loanable funds theory is a term in economics that is used to describe money that is available to borrow. It is another word for financial assets. The market for loanable funds is the market that brings borrowers and savers together. In particular, loanable funds consist of bank loans and household savings.
- Capital refers to money and the supply and demand of money in various markets. Typically, companies and those entities that provide goods and services are the demanders of capital. In other words, borrowers demand loanable funds, according to "Economics" by Walter J. Wessels. Similarly, households and those entities that purchase goods and services are the suppliers of capital. In other words, savers supply loanable funds. Furthermore, households may supply goods indirectly by saving portions of their incomes and putting them into savings accounts (lending them to banks).
- The interest rate is a cost of borrowing loanable funds, paid by the borrower to the lender. In other words, it is the rate of return. Interest rates are often considered as annual percentage rates (meaning that they are spread over a year). Compound interest is interest that is charged both on the principal balance and the accrued, unpaid interest of a loan.
- Equlibrium of the loanable funds market occurs when savings capital is equal to the investment capital, according to "Economics." It can be mathematically represented as National Savings = Domestic Investment + Net Foreign Investment. The particular price that brings the loanable funds market into equilibrium is the interest rate. In other words, loanable funds theory determines the equilibrium interest rate of a particular loan.
- When the demand and the supply curves are symbolized on the same graph, the demand curve slopes downward. This demonstrates that borrowers will demand more money at lower interest rates. On the other hand, the supply curve slopes upward and demonstrates that lenders are willing to supply more money at higher interest rates. As a result, the equilibrium interest rate is the point where the supply and the demand curves intersect.
- Other considerations of the loanable funds theory is the rate of return on capital. It is important to point out that the demand of loanable funds takes into account the additional revenue that the company can earn from its use of the money (called the rate of return on capital). In other words, a company's demand (just like the individual's) will continue as long as the rate of return on its capital continues to increase.
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