They each earn income (Y);
they each spend and consume (C );
they each save (S).
In a wholly Private Economy, Saving and Investment are Brought
into Balance with an Interest Rate of, say, 5%.
Bob
Carol
Ted
Alice
Rate of
Interest
S
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$1,100
$900
$1,000
5%
D
Saving @ 5%
$200
$400
$300
-$100
Net Saving by Bob, Carol, Ted, and Alice is $800.
Borrowing and Investing by the Business Community is $800.
$800
Loanable
Funds
Suppose that, with the Interest Rate Still at 5%,
Bob and Carol decide they’d like to save more.
Bob
Carol
Ted
Alice
Rate of
Interest
S
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$700
$1,100
$1,000
$900
$1,000
5%
D
Saving @ 5%
Saving @ 5%
$300
-$100
Now, net Saving by Bob, Carol, Ted, and Alice is $1,000.
But Borrowing and Investing is still $800.
Loanable
Funds
$1,000
$400
$500
$800
$200
$300
S
With a Surplus of Loanable Funds, the Interest Rate falls to 3%,
So, Bob, Carol, Ted, and Alice all make adjustments.
Bob
Carol
Ted
Alice
Rate of
Interest
S
Income
$1000
$1,500
$1,200
$900
Consumption
$800
$700
$720
$1,100
$1,000
$1,030
$900
$1,000
$910
$1,030
$200
$300
$280
$400
$500
$470
$300
-$100
Saving @ 5%
Saving @ 5%
3%
-$130
Now, net Saving by Bob, Carol, Ted, and Alice is $910.
And Borrowing and Investing is also $910.
Loanable
Funds
$1,000
$910
$290
D
$800
Saving @ 3%
5%
S
Bobmore Carol
Ted
Alice
When people save
(i.e., when they
consume
less), the interest rate falls.
Income
The
business $1000
community$1,500
responds by
borrowing $900
$1,200
more funds and using them to expand the economy’s
productive capacity.
This is
the market
at$900
work $1,000
Consumption
$800
$1,100
Resources freed up by the reduced consumption are
for$700
you
and
for me.
$1,000
used for creating
plant and
equipment and engaging
in longer-term production
activities. $910
$720
$1,030
$1,030
Rate of
Interest
S
5%
3%
D
Saving
also means
buying $300
power in the
Saving
@ 5%
$200increased
$400
-$100
Saving @ 3%
$280
$470
$290
-$130
Loanable
Funds
$1,000
$910
have come to fruition.
$800
future---when
the expanded investment activities
Saving
@ 5%
$300
$500
S