They each earn income (Y); they each spend and consume (C ); they each save (S).

Bob Carol Ted Alice

Income $1000 $1,500 $1,200 $900

Consumption $800 $1,100 $900 $1,000

Saving @ 5% $200 $400 $300 -$100

In a wholly Private Economy, Saving and Investment are Brought into Balance with an Interest Rate of, say, 5%.

Net Saving by Bob, Carol, Ted, and Alice is $800.

Borrowing and Investing by the Business Community is $800.

S

D

5%

$800

Rate ofInterest

LoanableFunds

Bob Carol Ted Alice

Income $1000 $1,500 $1,200 $900

Consumption $800

$700

$1,100

$1,000

$900 $1,000

Saving @ 5%

Saving @ 5%

$200

$300

$400

$500

$300 -$100

Suppose that, with the Interest Rate Still at 5%,Bob and Carol decide they’d like to save more.

Now, net Saving by Bob, Carol, Ted, and Alice is $1,000.

But Borrowing and Investing is still $800.

S

D

$800

5%

S

$1,000

Rate ofInterest

LoanableFunds

surp

lus

Bob Carol Ted Alice

Income $1000 $1,500 $1,200 $900

Consumption $800

$700

$720

$1,100

$1,000

$1,030

$900

$910

$1,000

$1,030Saving @ 5%

Saving @ 5%

Saving @ 3%

$200

$300

$280

$400

$500

$470

$300

$290

-$100

-$130

With a Surplus of Loanable Funds, the Interest Rate falls to 3%,So, Bob, Carol, Ted, and Alice all make adjustments.

Now, net Saving by Bob, Carol, Ted, and Alice is $910.

And Borrowing and Investing is also $910.

S

D

$800

5%

S

$1,000

3%

$910

Rate ofInterest

LoanableFunds

surp

lus

Bob Carol Ted Alice

Income $1000 $1,500 $1,200 $900

Consumption $800

$700

$720

$1,100

$1,000

$1,030

$900

$910

$1,000

$1,030Saving @ 5%

Saving @ 5%

Saving @ 3%

$200

$300

$280

$400

$500

$470

$300

$290

-$100

-$130

S

D

$800

5%

S

$1,000

3%

$910

Rate ofInterest

LoanableFunds

When people save more (i.e., when they consume less), the interest rate falls.

The business community responds by borrowing more funds and using them to expand the economy’s productive capacity.

Resources freed up by the reduced consumption are used for creating plant and equipment and engaging in longer-term production activities.

Saving also means increased buying power in the future---when the expanded investment activities have come to fruition.

This is the market at work for you and for me.