Definition
The loanable funds market is an economic model that treats borrowing and lending as a single market with a price. The "good" being traded is funds available for lending; the price is the real interest rate. Households and others who save supply funds to this market, while firms and governments that want to invest or finance deficits demand them.
In equilibrium, the quantity of funds saved equals the quantity borrowed, and the interest rate adjusts until they match. This simple supply-and-demand picture lets economists reason about how saving habits, government deficits, and capital flows push interest rates up or down.
Why it matters
How it works
The supply of loanable funds slopes upward: higher real interest rates reward saving, so people set aside more. The demand slopes downward: cheaper funds make more investment projects profitable, so firms borrow more. The intersection sets both the equilibrium interest rate and the volume of investment.
Shifts tell the story. A rise in government borrowing increases demand and pushes rates up. An inflow of foreign capital increases supply and pushes rates down. A tax change that discourages saving shifts supply left, raising the cost of capital for everyone.