Question

describe

1. equilibrium condition in a savings model with not assets

2. equilibrium condition in a saving model with government bonds

Answer 1

If there is no option to invest in the asset market like government bonds then all the funds people want to save will put them into savings. Hence absolute size of the savings size will increase. It will put upward pressure in the savings supply. Hence in the market loanable funds will increase. Hence we can see that interest rate will be low and total equilibrium savings/investment will be equal. 2. If there are provision of government bonds, some people may choose to invest in them as a alternative savings tool. Hence in the loanable fund market, there will be a shortage in the supply of loanable funds. Hence now in presence of the assets to invest in, the equilibrium interest rate will be high and total amount of equilibrium savings/investment will be low.

Now let's say price of government bond falls then people will buy more government bonds.

Why?

Government bonds are a security where government pays you back some amount after a period. Like you will be paid 120 dollars after 3momths. Now if the bond price is 100 then your gain will be 20% but if the price is 110 then your gain will be around 9%. Hence increasing the price of bonds will discourage people to invest in the bonds. Hence loanable market will have more supply of funds and interest rate will drop and equilibrium savings and investment will be higher. Hence bond price has a inverse relationship with interest rate and has a direct relationship between equilibrium savings and investment quantity.

I hope you understood the concept and I solved your question.

Have a great day ahead.

Give good feedback.

Comment down if you have anything to ask about the answer.