In economics, the loanable funds market is a conceptual market where savers (suppliers) and borrowers (demanders) are able to establish a market clearing quantity and price (interest rate). In the loanable funds market, market clearing is defined as the interest rate/loanable funds quantity where savings equal investment (the amount of capital needed for property, plant, and equipment based investments) . Loanable funds are typically cash, but can also include other financial assets to serve as an intermediary.
Equilibrium in the loanable funds market
When the supply and demand for loanable funds are equal, savings is equal to investment and the loanable funds market is in equilibrium at the prevailing interest rate.
For instance, buying bonds will transfer savers' money to the institution issuing the bond, which can be a firm or government. In return, the borrower's (institution issuing the bond) demand for loanable funds is satisfied when the institution receives cash in exchange for the bond.
Loanable funds are often used to invest in new capital goods. Therefore, the demand and supply of capital is usually discussed in terms of the demand and supply of loanable funds.
Interest rate
The interest rate is the cost of borrowing or demanding loanable funds and is the amount of money paid for the use of a dollar for a year. The interest rate can also describe the rate of return from supplying or lending loanable funds.
As an example, consider this: a firm that borrows $10,000 in funds for one year, at an annual interest rate of 10%, will have to pay the lender $11,000 at the end of the year. This amount includes the original $10,000 borrowed plus $1,000 in interest; in mathematical terms, this can be written as $10,000 × 1.10 = $11,000.