Question

1) Let’s analyze how the following situations will affect the market for loanable funds.

a) Suppose that there is a higher government deficit.

Higher government deficit will the  (demand or supply) for loanable funds to shift to the  (left or right). As a result, the equilibrium interest rate will  (decrease or increase) and the equilibrium amount of loanable funds will  (decrease or increase).

b) Suppose that there are more social welfare programs.

More social welfare programs will cause the  (demand or supply) for loanable funds to shift to the  (left or right). As a result, the equilibrium interest rate will  (decrease or increase) and the equilibrium amount of loanable funds will  (decrease or increase).

c) Suppose that there are a higher government deficit and more social welfare programs at the same time.

There are three cases of change in equilibrium.

In all three cases, the equilibrium interest rate will definitely  (increase or decrease).

If supply changes more than demand changes, the equilibrium amount of loanable funds will  (increase or decrease or stay the same).

If supply changes less than demand changes, the equilibrium amount of loanable funds will  (increase or decrease or stay the same).

If supply changes by the same amount as the demand changes, the equilibrium amount of loanable funds will  (increase or decrease or stay the same).

2) Suppose that consumption is $10 trillion, investment is $4 trillion, government spending is $4 trillion, taxes are $3 trillion, and capital inflow is $1.2 trillion and capital outflow are $0.8 trillion.

a) Suppose that there is no government and the economy is a closed economy.

The private saving is $  trillion because private saving is equal to  without a government and trade.

b) Suppose that there is a government and the economy is a closed economy.

The public saving is -$  trillion. As a result, there is a budget  (surplus or deficit). The private saving is $  trillion.

c) Suppose that there is a government and the economy is an open economy.

The net capital flow is $  trillion. As a result, there is a net capital  (inflow or outflow). Investment is  (greater or less) than national saving.

Answer 1

1. a) Suppose that there is a higher government deficit. So the government will also need funds to finance its defecit which they will borrow from the market and hence the demand will increase hence demand curve will shift to the right. As a result the equilibrium interest rate will increase to i1 and equilibrium amount of funds will also increase to Q1 as shown in fig. (a).

b) Suppose that there are more social welfare programmes, so there will be more money with the public and hence the supply of loanable funds will increase which will shift the supply curve to the right. As a result the equilibrium interest rate will decrease and the equilibrium amount of loanable funds will increase as shown in fig.(b).

c) If there are high government deficit and more social welfare program at the same time, than there will be three situations.

Case (i) - If supply changes more than demand, than the equilibrium amount of loanable funds will increase.

Case (ii) If supply changes less than the demand changes, the amount of loanable funds will increase.

Case (iii) If supply changes by the same amount as demand changes, equilibrium amount of loanable funds will increase.

All these changes have different effects on interest rates but in all cases there is a rise in the quantity of loanable funds.