Suppose people now have higher time preferences. How would this affect the loanable funds market? Show...

Suppose people now have higher time preferences.

How would this affect the loanable funds market? Show your answers in a graph.

Would GDP increase or decrease?

2. Can real interest rate be higher than nominal interest rate? Explain.

Expert Solution

1a) As people have high time preferences, they will like to purchase goods now rather than at any point of time in future. It will reduce overall savings of people in the economy which reduces supply of loanable funds. Leftward shift in the loanable supply curve will raise the rate of interest in an economy because people willing to borrow money will offer higher rate of interest to lenders. Equilibrium occurs when demand of loanable funds = supply of loanable funds. When supply curve shift from grey line to orange line, it will raise rate of interest.

2a) Aggregate demand = Consumption + Investment + Government spending + Exports - Imports. Rise in rate of interest will reduce investment level which will reduce overall GDP level.

2) Nominal Interest = Real Interest + Inflation Rate

Real Interest can be higher than Nominal Interest but it will result in negative inflation which means there is deflation or fall in overall price level in the economy.

Rahul Sunny answered 2 years ago

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