Figure 15-5 The Capital Market
Figure 15-5 shows how the interest rate is determined in the capital
market. The intersection of the investment demand curve and the saving
supply curve determines the equilibrium interest rate,. If the interest
rate were above , there would be an excess supply of capital;
households’ desired saving would exceed firms’ desired borrowing. This
excess supply of capital would cause the interest rate—the price of
financial capital—to fall. Conversely, if the interest rate were below
there would be an excess demand for capital; firms’ desired borrowing
would exceed households’ desired saving. This excess demand for capital
would cause the interest rate to rise. Only at is the market in
equilibrium—the quantity of investment demanded by firms is just equal
to the quantity of saving supplied by households.
At the equilibrium interest rate, the quantity of investment demanded
equals the quantity of saving supplied. The equilibrium interest rate is
where the quantity of investment demanded by firms equals the quantity
of saving supplied by households (point E).
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