Question

The table shows an​ economy's demand for loanable funds schedule and the private supply of loanable funds schedule when the​ government's budget is balanced.

What is the real interest​ rate, the quantity of​ investment, and the quantity of private saving if the​ government's budget becomes a deficit of

​$2.0

​trillion? Does crowding out​ occur?

If the​ government's budget becomes a deficit of

​$2.0

​trillion, the real interest rate is ___

percent a​ year, the quantity of investment is ___

​trillion, and the quantity of private saving is ___

trillion.

​>>> Answer to 1 decimal place.

Real interest rate ​(percent per​ year)	Loanable funds demanded	Loanable funds supplied
	​(trillions of 2009 dollars per​ year)
4	6.5	4.5
5	6.0	5.0
6	5.5	5.5
7	5.0	6.0
8	4.5	6.5
9	4.0	7.0
10	3.5	7.5

Answer 1

Before government's budget becomes a deficit of $2 trillion, market for loanable funds was in equilibrium corresponding to real interest rate of 6% per year as quantity demanded of loanable funds and quantity supplied of loanable funds are equal to each other corresponding to this real interest rate.

Equilibrium quantity of private investment was $5.5 trillion.

Now, government's budget becomes a deficit of $2 trillion. This will lead to increase in demand for loanable funds at each real interest rate by $2 trillion.

Following is the adjusted table -

Real interest rate	Loanable funds demanded	Loanable funds supplied
4	8.5	4.5
5	8.0	5.0
6	7.5	5.5
7	7.0	6.0
8	6.5	6.5
9	6.0	7.0
10	5.5	7.5

After budget deficit, market for loanable funds is in equilibrium corresponding to real interest rate of 8% per year.

Equilibrium quantity of loanable funds is $6.5 trillion.

Out of this, $2 trillion would be demanded by government and $4.5 trillion by private borrowers.

So,

The real interest rate is 8% per year.

The quantity of investment is $6.5 trillion.

The quantity of private saving is $6.5 trillion.

The private investment is decreasing from $5.5 trillion to $4.5 trillion.

So, crowding out occurs.