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An individual’s choices over time determine how much he or she will borrow or lend. In particular, individual loan supply is upward sloping: when the real interest rate increases, a typical household will supply a greater quantity of funds to the credit market. Market loan supply is obtained by adding together the individual loan supplies of everyone in an economy. We use the terms “credit” and “loans” interchangably.
The demand for credit comes from households and firms that are borrowing. Market loan demand is obtained by adding together all the individual demands for loans. When real interest rates increase, borrowing is more expensive, so the quantity of loans demanded decreases. That is, loan demand obeys the law of demand.
Borrowers and lenders interact in the credit market (or loan market), which is illustrated in Figure 31.4 "The Credit Market (or Loan Market)". Credit market equilibrium occurs at the real interest rate where the quantity of loans supplied equals the quantity of loans demanded. At this equilibrium real interest rate, lenders lend as much as they wish, and borrowers can borrow as much as they wish. All gains from trade through loans are exhausted in equilibrium.
Figure 31.4 The Credit Market (or Loan Market)