Question

Practice FRQ Loanable Funds

A country is at full employment and produces two types of goods: consumer goods and capital goods.

1. Draw a correctly labeled graph of the production possibilities curve, with consumer goods on the horizontal axis and capital goods on the vertical axis. Indicate a point on your graph, labeled X, that represents full employment and a possible combination in which goods are being produced.
2. Assume there is an increase in the country’s national savings. Draw a correctly labeled graph of the loanable funds market, showing the change in the real interest rate from the increase in savings.
3. On the graph from part ( a ), show another point, labeled Z, that represents full employment and a new combination of consumer goods and capital goods consistent with the increase in the country’s national savings.
4. Referring to your answer in part ( c ), will the long run aggregate supply curve shift to the right, shift to the left, or remain the same? Explain.

Answer 1

a.Refer to figure below:Fig. A: It shows different possibilities of consumer and capital goods along the production possibility curve which shows different combinations of output possible.

B.:Refer to figure below:Fig. B: As savings increase supply of loanable funds will shift to right and interest rates will come down.

C. Z shows another combination of goods with same resources. In this case it is true that savings has increased but quality and quantity of resources is still the same. Possible combination of goods will change along the PPC curve.

D. Not immediately. Factors that shift LRAS are: Increase in the quantity of scarce resources, such as inward migration or organic population growth, or improvements in the quality of resources, such as through better education and training. Nothing of this sort has happened. It is true that increased savings if properly channeled then it will lead to increased investments and productivity which will shift LRAS but not immediately.