Question

Assuming that the US government decides to subsidize applications for student loans.

How will such policy affect the equilibrium in the financial market?

What will happen to the interest rate as well as quantity of money in the market?

Answer 1

If US government decides to Subsidize applications for student loans, this means that the students will be provided with financial help from the government. In other words it means that the students will be provided with the lower cost loans i.e. loans at a lower interest rates. Since students need money for their education and hence they take education loans which costs them a large amount as interests. But government recognises that education is a very necessary good and hence they provide subsidy on loans to increase the consumption of this good( increase in education).

This decision of the government will effect the financial market equilibrium, as it is the market where the Demand for money (Md) and Supply of money (Ms) is studied. Subsidy on education loans will increase the supply of money in the market and hence the interest rates will come down. This can be shown graphically as -

It can be seen from the graph that increase in the supply of money shifts the Ms curve to Ms1 and hence the new equilibrium is determined where -

Interest rate comes down to a lower level from r to r1 and the quantity if money increases from Q to Q1.