Interest Rate Determination: Loanable Funds Theory And Keynesian Theory
Economics notes
Interest Rate Determination: Loanable Funds Theory And Keynesian Theory
➡️ Loanable Funds Theory: This theory states that the interest rate is determined by the supply and demand of loanable funds in the market. The supply of loanable funds is determined by the savings of households and the demand is determined by the investment of firms. When the supply of loanable funds is greater than the demand, the interest rate will decrease, and vice versa.
➡️ Keynesian Theory: This theory states that the interest rate is determined by the level of aggregate demand in the economy. When aggregate demand is high, the interest rate will increase, and when aggregate demand is low, the interest rate will decrease. This is because when aggregate demand is high, firms will need to borrow more money to finance their investments, and this will cause the interest rate to increase.
➡️ Both theories agree that the interest rate is determined by the supply and demand of loanable funds in the market. However, the Keynesian theory also takes into account the level of aggregate demand in the economy, which the Loanable Funds Theory does not.
What is the loanable funds theory of interest rate determination?
The loanable funds theory suggests that interest rates are determined by the supply and demand for loanable funds in the market. The supply of loanable funds comes from savings, while the demand for loanable funds comes from borrowers who want to invest in projects or make purchases. As the supply of loanable funds increases, interest rates decrease, and vice versa.
What is the Keynesian theory of interest rate determination?
The Keynesian theory suggests that interest rates are determined by the level of investment and the level of savings in the economy. According to this theory, interest rates are not solely determined by the supply and demand for loanable funds, but also by the level of aggregate demand in the economy. When there is a high level of investment and low level of savings, interest rates tend to be high, and vice versa.
How do the loanable funds theory and Keynesian theory differ in their approach to interest rate determination?
The loanable funds theory focuses on the supply and demand for loanable funds, while the Keynesian theory takes into account the level of investment and savings in the economy. The loanable funds theory assumes that interest rates are solely determined by the market forces of supply and demand, while the Keynesian theory suggests that interest rates can be influenced by government policies and changes in aggregate demand. Additionally, the loanable funds theory assumes that individuals and firms are rational and make decisions based on their self-interest, while the Keynesian theory suggests that individuals and firms may not always act rationally and may require government intervention to stabilize the economy.