Question

1. How does a decrease in expected profit affect the demand for loanable funds (investment demand)? Which way does the curve shift?

2. Explain how a government budget deficit might crowd out private investment.

3. What is the effect on real GDP per person if labor productivity increases? If the population increases? What is the effect on the nation's standard of living in each case?

4. What does the new growth theory predict about future economic growth? Why?

Answer 1

Ans) 1) Demand of loanable fund comes from the borrowers and supply comes from the savers. The main demander of loans are the businesses. When they expect low returns, they will invest less and hence will borrow less.

As a result, demand for loanable funds will decrease and demand curve will shift to the left. Both interest rate and quantity will decrease.

2) When government runs a budget deficit, it borrows huge quantity from the market. As a result demand curve shifts to the right and interest rate increases.

Due to increase in interest rates, amount borrowed by private entities decreases and hence investment decreases. This is known as crowding out.

Q2 - Q1 = amount borrowed by government and Private investment has decreased to Q2.

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