Final answer:
If there is a shortage of loanable funds, the interest rate will rise. This occurs because the scarcity of funds allows lenders to charge more for loans. Factors such as contractionary monetary policy can reduce loanable funds and increase interest rates, while an increase in lenders can drive rates down.
Step-by-step explanation:
If there is a shortage of loanable funds, then the price of borrowing money, which is the interest rate, will go up. This scenario can be compared to the law of supply and demand, where a shortage of goods leads to an increase in price. In the context of loanable funds, when there are not enough funds to satisfy the demand for loans, lenders can charge a higher interest rate. Conversely, an increase in the amount of available loanable funds, where there are more people wanting to lend, results in competition among the lenders, which bids down the interest rate.
Using contractionary monetary policy as another example, we can see that when the government enacts measures to reduce the money supply, this usually leads to a reduction in the amount of loanable funds. Because of the reduced supply, the interest rate is driven up due to greater scarcity. On the other hand, if conditions change such that there are more people who want to borrow and more people who want to lend, the quantity of loans will increase, and the market will adjust to these changes in supply and demand.