Question

7. Three students have each saved $1,000. Each has

an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students’ investment projects:

Harry 5percent Ron 8percent Hermione 20 percent

a. If borrowing and lending are prohibited, so each student uses only personal saving to finance his or her own investment project, how much will each student have a year later when the project pays its return?

b. Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate r. What would determine whether a student would choose

to be a borrower or lender in this market?

c. Among these three students, what would be the

quantity of loanable funds supplied and quantity demanded at an interest rate of 7 percent? At

10 percent?

d. At what interest rate would the loanable funds market among these three students be in equilibrium? At this interest rate, which student(s) would borrow and which student(s) would lend?

e. At the equilibrium interest rate, how much does each student have a year later after the investment projects pay their return and loans have been repaid? Compare your answers to those you gave in part (a). Who benefits from the existence of

the loanable funds market—the borrowers or the lenders? Is anyone worse off?

Answer 1

Solution:-

Given that

Investment means the purchase of goods or an asset that is not being consumed today but is used in the future to create wealth.

Three studens have saved $1000 each. Each has an opportunity in which he or she can invest up to $ 2000. The rates of return on the students investment projects are given as follows.

Harry 5 percent

Ron 8 percent

Hermione 20 percent

a)

Calculate the amount each student has a later when the project pays its returns as follows:

Calculate the amount of person H as follows:

Amount = Investment + Interest

= 1000 + 5% on 1000

= 1000 + 50

= 1050 $

Thus, the amount person H has a year later is $ 1050

Calculate the amount of Person R as follows:

Amount = Investment + Interest

= 1000 + 8% on 1000

= 1000 + 80

= 1080$

Thus, the amount person R has a year later is $ 1080

Calculate the amount if person Hn as follows:

Amount = Investment + Interest

= 1000 + 20% on 1000

= 1000 + 200

= $ 1200

Thus, the amount person Hn has a layer is $1200

b)

If the school opens up a market for lonable funds in which students can borrow and lend money at an interest rate.

If the rate of retun on the students investment project us less than the market rate if interest then the student would be a lender, otherwise he or she would be a borrower.

c)

At an interest rate of 7 percent, $1000 fund would be supplied by Person H, but there would be demand for $2000 funds by Person R and Person Hn, each demanding $1000 for his or her investment project.

At an interest rate of 10 percent $ 2000 fund would be supplied by Person H and Person R, each contributing $ 1000. Person H would demand $1000 fund for his project.

d)

The lonable fund market among these three students would be an in equilibrium at 8% rate of interest.

At 8% interest aret, Person Hn would borrow and Person H would lend $ 1000.

e)

Calculate the amount of each students at equilibrium interest rate of 8% percent loans have been paid as follows:

Calculate the amount of person H as follows:

Amount = Investment + Interest

= 1000 + 8% on 1000

= 1000 + 80

= $ 1080

Thus, the amount person H has at the equilibrium interest arte after the loans have been paid is $ 1080.

Calculate the amount of person R as follows

Amount = Investment + Interest

= 1000 + 8% on 1000

= 1000 + 80

= 1080

Thus, the amount person R has at the equilibrium interest rate after the loans have been paid is $ 1080.

Calculate the amount of person Hn as follows

Amount = Investment + Interest

= (1000 + 200) + (1000 + 120)

= 12000 + 1120

= $ 1320

Thus, the amount person Hn has at the equilibrium interest rate after the loans have been paid is $ 1320.

Note that person Hn earns 20 percent on her own $1000 and 12 percent on the amount borrowed from Person H.

Calculate the interest drawn as follows:

Interest drawn = 200 + (200 - 80)

= 200 + 120

= $ 320

Thus, Person Hn draws an interest of $ 320 is left after playing back the loan to Person H.

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