Interest Rates Essay Example | Topics and Well Written Essays - 500 words

Interest Rates - Essay Example Thirdly and lastly, the lender has to be compensated for the decrease in value of the money due to inflation, for example a dozen eggs might cost 100rs today and after a year they might cost 110rs, so if I have loaned any one 100rs I will want 110rs back because that is what 100rs is NOW worth or that is the equivalent value. There are basically two theories that explain how interest rates are decided upon, one is the 'Loanable Funds Theory' also known as the classical theory and the other one is 'Keynesian Theory' also known as the liquidity preference theory. The loanable funds theory is the older one of the two theories and according to this theory the interest rates are determined by the demand for loanable funds by firms and the supply of these funds by the banking and other investment funds, it suggests that interest rates are determined in the same way as demand for other goods and services is determined i.e. by finding the equilibrium position of the demand and supply of the relative product.