In the loanable funds framework, other things the same, what happens to the supply of loanable funds when the interest rate rises?

Introduction / Context:
The loanable funds model is used in macroeconomics to analyse how interest rates are determined by the interaction of saving and investment. Questions often ask how changes in the interest rate affect the supply and quantity of loanable funds, which helps distinguish between movements along a curve and shifts of the curve. Understanding this distinction is essential for interpreting diagrams and policy effects in the loanable funds framework.

Given Data / Assumptions:

• The supply of loanable funds represents the willingness of people to save and lend at different interest rates.
• The demand for loanable funds represents the willingness of firms and others to borrow for investment and other purposes.
• All other determinants of saving behaviour are assumed constant when considering the effect of a change in the interest rate.
• Interest rate changes cause movements along the supply curve unless underlying saving preferences shift.

Concept / Approach:
In the loanable funds model, a higher interest rate makes saving more attractive because lenders receive more return for each unit of funds they supply. As a result, people are generally willing to lend more when interest rates are higher, increasing the quantity of loanable funds supplied. This change is a movement along the existing upward sloping supply curve, not a shift of the curve itself. A shift in the supply curve would require a change in factors such as preferences between present and future consumption or fiscal policies that affect saving incentives. The correct option must state that people lend more and that the quantity supplied increases along the curve.

Step-by-Step Solution:
Step 1: Recall that the supply of loanable funds curve slopes upward, reflecting higher quantities supplied at higher interest rates. Step 2: Recognise that a change in the interest rate, holding other factors constant, causes a movement along this existing supply curve. Step 3: Understand that when the interest rate rises, the reward for saving and lending increases, encouraging more saving. Step 4: Conclude that people will want to lend more, so the quantity of loanable funds supplied increases, consistent with a movement along the supply curve. Step 5: Choose the option that correctly describes this movement and does not confuse it with a shift in the entire supply curve or with a decrease in lending.

Verification / Alternative check:
Imagine that at an interest rate of 4 percent, households in an economy collectively supply 100 units of savings to the loanable funds market. If the interest rate rises to 6 percent, some households may choose to save more because the higher return makes future consumption more attractive relative to present consumption. At 6 percent, they may supply 130 units of savings. This increase from 100 to 130 units is a higher quantity of loanable funds supplied, corresponding to a movement upward along the supply curve. The underlying relationship between interest rate and supply has not changed, so the curve itself has not shifted. This example supports the description in the correct option.

Why Other Options Are Wrong:
Option A is wrong because higher interest rates would not normally make people want to lend less; they would encourage more saving, not less. Option B incorrectly states that a higher interest rate leads to a decrease in the quantity supplied, which contradicts the upward slope of the supply curve. Option C wrongly implies that the supply curve shifts when interest rates change, but a shift requires a change in non price determinants. Option E falsely claims that supply and quantity remain unchanged regardless of the interest rate, which is inconsistent with basic economic theory.

Common Pitfalls:
A common pitfall is to confuse a movement along a curve with a shift of the curve, especially under exam pressure. Another mistake is to forget that the supply curve is upward sloping and to assume that a higher interest rate might discourage saving. Some learners also mix up the effects on demand and supply, assuming that higher interest rates always lead to lower lending simply because borrowing becomes more expensive, without considering the saving side. Remembering that interest rate changes cause movements along the loanable funds supply curve while changes in underlying saving preferences shift the curve helps avoid these errors.

Final Answer:
People would want to lend more, making the quantity of loanable funds supplied increase as a movement along the existing supply curve.