Question

For each event below indicate the outcome in the loanable funds market. Indicate whether the supply or demand of loanable funds shifts and in what direction. Specify what happens to the real interest rate, the quantity of national saving and the quantity of investment. Unless specified, assume the government has a balanced budget.

a. The amount Canadians can contribute to their Registered Retirement Savings Plan (RRSP) is increased.

b.  The federal government experiences a budget deficit as it borrows billions for Covid-19 spending.

Answer 1

a) An increase in savings in loanable funds market will shift the supply curve rightwards .

National Savings -: Increase.

Quantity of Investment -: Increase.(due to availability of more funds)

Real Interest Rate -: Decrease (Availability of more funds for borrowing will make the decline cost of borrowing due to large pool of funds ).

b) A deficit in govt budget due to borrowing will shift the decrease the supply of loanable funds and there will be leftwards shift in supply curve(of loanable funds).

National Savings -: Decrease.

Quantity of Investment -: Decrease.

Real Interest Rate -: Increase.

Reason -: Due to budget deficit , govt will tend to borrow more and thus reduce the savings for private users as the people's savings are absorbed for govt borrowing purpose. Hence . a decrease in savings will increase the interest rate . The quantity of investment will thus be decreased due to high interest rates i.e. high cost of borrowing .