When an investor makes money on a short, who loses the money?

Not really. The lender is not buying the stock back at a lower price. Remember, he already owns it, so he need not buy it again.

The person losing is the one from whom the short seller buys back the stock, provided that person bought the stock at higher price.

So if B borrowed from A(lender) and sold it to C, and later B purchased it back from C at a lower price, then B made profit, C made loss and A made nothing .

Michael gave a good answer describing the transaction but I wanted to follow up on your questions about the lender.

First, the lender does charge interest on the borrowed securities. The amount of interest can vary based on a number of factors, such as who is borrowing, how much are they borrowing, and what stock are they trying to borrow.

Occasionally when you are trying to short a stock you will get an error that it is hard to borrow. This could be for a few reasons, such as there are already a large amount of people who have shorted your broker's shares, or your broker never acquired the shares to begin with (which usually only happens on very small stocks). In both cases the broker/lender doesnt have enough shares and may be unwilling to get more. In that way they are discriminating on what they lend. If a company is about to go bankrupt and a lender doesnt have any more shares to lend out, it is unlikely they will purchase more as they stand to lose a lot and gain very little.

It might seem like lending is a risky business but think of it as occurring over decades and not months. General Motors had been around for 100 years before it went bankrupt, so any lender who had owned and been lending out GM shares for a fraction of that time likely still profited.

Also this is all very simplified. JoeTaxpayer alluded to this in the comments but in actuality who is lending stock or even who owns stock is much more complicated and probably doesnt need to be explained here. I just wanted to show in this over-simplified explanation that lending is not as risky as it may first seem.

Nobody; or at least, no individual counterparty.

Let’s use (mostly) @Michael’s labels of borrowing securities from beneficial owner A via broker B, sell high to C and buy back low from D. Note that in this answer, B refers to the broker rather than the borrower.

A: starts with the securities and ends with the same. The broker makes good if A wants to trade while the securities are on loan.

B: charges interest for the loan, so makes a profit. B may sustain a loss if A sells during the loan and B can not recover the securities from the borrower, but this is not directly a loss due to the borrower’s profit.

C: willing buyer. The price might go up before it comes down, or it might go up later. C could sell at either opportunity, so the borrower’s profit isn’t directly tied to C.

D: willing seller (at least, not necessarily a forced sale). D might have bought even lower beforehand, so the borrower’s profit isn’t always/necessarily funded by a loss here.

The situation is like hiring machinery to produce goods for sale. The hirer can make a profit without anyone making a loss.

Alternatively, consider the situation where you bought low first and sold high later. A, B, C and D have exactly the same profit/loss profiles. Assuming all are willing parties to the transactions, there is no single party that sustains a loss to produce your gain.

The real loss comes from C and D, taken together.

Philosophically, you could perhaps say that it is the underlying security itself that sustains the loss. Selling a security exerts a downward pressure on its price and contributes to the profit gained when it is repurchased. The underlying company loses market capitalisation by the price drop, but it is not a crystallised loss on the basis of being the underlying company.

Between the time the borrowed shares (say N shares) are sold and the time they are bought to cover, the number of long shares held by other investors is N greater than it would be "otherwise" -- i.e., than it would be in the baseline scenario where the short wasn't performed.

Which investors exactly (as a function of time) hold the "extra" N shares is a complex counterfactual question of market dynamics. (It's not just about trades that happened that otherwise wouldn't have happened, but also about trades that didn't happen that otherwise would have happened.)

But whoever the investors holding the extra N shares are, if the stock declines by $A during this period, they have a collective loss of $A x N compared to the baseline -- which matches the profit made by the short seller.

There were some valiant attempts to answer the question but several got lost on the way with needless complexities.

The simple answer is that anyone who is long the stock during share price drop loses money. Anyone who is short the stock during share price drop makes money.

The gains and losses are unrealized until closing positions are taken, at which time the gains or losses are realized.

It is possible that NOBODY would lose money in such a scenario, even though it was pointed out in one answer that whoever buys the shorted shares loses. That's only true if the shares never recover to the same they were at to begin with.

It's only a loss if a) the shorted stock never recovers back to (or past) the price at which they were shorted or b) the person who bought the shorted shares chooses to bail out and take their lumps before the stock has the chance to recover.

Profits and losses are only theoretical until someone actually makes a trade that turns them into reality. How many "paper millionaires" are there who didn't pull the trigger on a trade when they should have and watched it all evaporate because of that indecision?

Day trading takes advantage of temporary dips in the prices of otherwise healthy stocks, so just because someone buys shorted shares at a temporarily-depressed price doesn't mean they lose money, so long as they ride out the dip (if they can stand the risk and ulcers!) and don't bail out of the stock. That's when the loss is realized.