When prevailing interest rates sit below the equilibrium borrowing rate for loanable funds, the financial system exhibits _________?
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Answer: B. deficit of funds
Explanation
When prevailing interest rates sit below the market equilibrium, borrowing demand surges. At this low rate, the quantity of funds demanded exceeds the quantity of funds supplied. This imbalance creates a structural deficit or shortage of loanable funds in the system. Market equilibrium balances the quantity of capital demanded with the quantity supplied. Price controls or artificial rate caps below equilibrium consistently trigger shortages. Lenders pull back capital when prevailing rates fail to compensate for credit risks.
Borrowers scramble for financing when interest rates are held artificially below market clearing levels. Credit rationing by banks becomes common during periods of severe fund deficits. Market forces eventually push interest rates back up toward equilibrium to clear the shortage. Surplus of funds occurs when prevailing interest rates sit above the market equilibrium level. Short-term funds refers to maturity horizons rather than market supply and demand imbalances. Long-term funds describes capital duration rather than credit shortage conditions.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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