b. The economy moves through business cycles, with periodic expansions, when eco

Question

b. The economy moves through business cycles, with periodic expansions, when economic activity is higher than average, and economic slowdowns, which, if severe enough, can lead to a recession. During expansion periods the volume of loanable funds available from the financial system tends to increase and real interest rates tends to rise. With this information, explain the following:

1- why does the demand of loanable funds tend to increase during expansions?

2- why does the supply of loanable funds tend to increase during expansions?

3- does the supply of loanable funds tend to increase by more or less the demand during expansions?

Explanation / Answer

1. In an expanding economy there are various opportunities for investment. People expect a higher rate of return on their investment and want to engage in more business activities. How's the demand for loanable funds increases during expansion.

2. As the demand for loanable funds increases the interest rate is pushed higher. People are enticed with the higher rates of interest available on loanable funds. They hence save less and make more funds available for expansion thus increasing the supply of loanable funds.

3. The demand for loanable funds is thus higher than that of supply which explains why the economy is expanding.

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