§11. Deciding Whether to Borrow or to Lend

Individual character and income together with the market rate of interest determine what the individual will do in any given situation. Chart 32 pictures graphically one step in the process by which an individual adjusts his degree of impatience to the market rate of interest, by borrowing or lending.

To summarize and repeat, with the interest rate at 10 per cent, Individual 1 may, or may not, be willing to take a $100 loan, depending upon whether or not, while his position is at P1, his impatience is or is not greater than this 10 per cent. If, as portrayed by Chart 32, his impatience is greater—say, 30 per cent—and if he can obtain the loan at 10 per cent, he will be glad to do so. Let W1' be the position to which he is willing to shift Edition: current; Page: [251] in order to get $100 added to his present income. This position would require a sacrifice of $130 out of next year's income, which, however, he need not make for he can get his accommodation for $110 of next year's income and find himself at M1'.

Individual 2, on the other hand, whether because of his temperament, or because of a different time distribution of his income, may behave quite differently. His position to start with, let us say, is P2 in Chart 33. If his impatience, under these circumstances, is only 2 percent, when the market rate is 10 per cent, he will not borrow, but will lend. He will continue to lend until his degree of impatience is as great as the market rate of interest, that is as long as his Willingness line, at each stage, is less steep than the Market line.

Thus, the angle at P between the M line and W line Edition: current; Page: [252] of Individual 1, or of any other individual, shows whether that individual is potentially a borrower or a lender. If the individual's W line is steeper than the M line, he will borrow; if it is less steep, he will lend.

Therefore, if this second individual lends $100, while the first individual borrows $100, both at 10 per cent, both will reap advantage. One will shift down a 10 per cent Market line from P1 to M'1, and the other will shift up the 10 per cent Market line from P2 to M'2.

If we had only these two persons trading this year's income for next year's income between themselves, the rate of interest agreed upon for a loan of $100 this year would not, of course, necessarily be 10 per cent, but would be determined by the respective bargaining power of Individual 1 and Individual 2. The rate might fall anywhere between the 2 per cent, the lowest rate at which Individual 2 is willing to lend $100, and the 30 per cent, the highest rate, at which Individual 1 is willing to borrow $100. But we are less interested in such a special trade, or haggle than in the general market.