Chapter 25, Problem 10P

To determine

How the change in the expected future inflation rate affect the equilibrium quantity of loanable funds.

Concept introduction:

Loanable Funds Market: It is an imaginary market which illustrates the market result of the demand for funds which are generated by borrowers and supply of funds which are provided by the lenders.

Demand for Loanable Funds: It is represented by a downward sloping curve which indicates that as the interest rate increases the demand for loanable funds decreases and vice versa.

Supply for Loanable Fund: It is represented by the curve that slopes upward which means that as the interest rate increases the supply of loanable fund also increases and vice versa.

Equilibrium Interest Rate: In the loanable fund market the point where demand curve and supply curve intersect each other gives the equilibrium interest rate.

Change in Interest Rate: Interest rate depends on several factors. One such factor is expected inflation rate. The relationship of interest rate and inflation rate is described by Fisher effect.

Inflation: When the price of any good increases continuously for an interval of time it is called inflation.

Fisher Effect: According to this effect when there is a rise in expected inflation rate then there is always a rise in nominal interest rate provided loanable fund quantity and interest rate do not change.