Question

In: Economics

a. use a loanable fund diagram to analyse the impact of the decrease in government expenditure...

a. use a loanable fund diagram to analyse the impact of the decrease in government expenditure on the interest rate investment and national saving

b. the bank syste, has 50 million in deposit and 10 million in reserve and there are no excess reserves. the public hold 5 million in cash. assume that the centrl bank sells 5 million government bonds in open market peration. calculate the change in money supply resulted from above policy and show its effects on interest rates and money quantity in the money market diagram

Solutions

Expert Solution

(a)

The decrease in government spending decreases government budget deficit, so government borrowing for deficit financing decreases, which decreases the demand for loanable funds. Demand curve shifts leftward, decreasing interest rate and decreasing quantity of lanable funds (national saving and investment).

In following graph, D0 and S0 are initial demand and supply curves for loanable funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds Q0. A decrease in demand shifts D0 leftward to D1, intersecting S0 at point B with lower interest rate r1 and lower quantity of loanable funds Q1.

(b)

Required reserve ratio (rr) = Reserve / Deposit = 10/50 = 0.2

Currency-deposit ratio (cr) = Currency / Deposit = 5/50 = 0.1

Money multiplier (MM) = (1 + cr) / (cr + rr) = (1 + 0.1) / (0.1 + 0.2) = 1.1 / 0.3 = 3.67

When central bank sells bonds worth 5 million,

Decrease in money supply = 5 million x 3.67 = 18.35 million

In the money market, a decrease in money supply will shift money supply curve leftward, increasing interest rate and decreasing quantity of money.

In following graph, MD0 and MS0 are initial money demand and supply curves, intersecting at point A with initial interest rate r0 and quantity of money M0. When money supply falls, MS0 shifts left to MS1, it intersects MD0 at point B with higherr interest rate r1 and lower quantity of money M1.


Related Solutions

The government expenditure in a closed economy increases by $1 billion. Use a diagram to explain...
The government expenditure in a closed economy increases by $1 billion. Use a diagram to explain the effect on: rate of interest; investment; private saving; national saving.
Describe briefly the factors of productivity, Open with ii) Using the market for loanable fund diagram,...
Describe briefly the factors of productivity, Open with ii) Using the market for loanable fund diagram, show graphically and explain how the interest rate and investment are affected in each of the following cases. (Draw a separate diagram for each.) a. A book titled "Live for Today' convinces people to spend more. b. Government sells bonds to the public, c. Tax on interest income decreases.
ii) Using the market for loanable fund diagram, show graphically and explain how the interest rate...
ii) Using the market for loanable fund diagram, show graphically and explain how the interest rate and investment are affected in each of the following cases. (Draw a separate diagram for each.) a. Tax on corporate profits increase. b. Government buys bonds from the public. c. Tax on interest income increases.
Draw a supply/demand diagram of the market for "loanable funds" in the U.S. Use the "interest...
Draw a supply/demand diagram of the market for "loanable funds" in the U.S. Use the "interest rate" as the "price" of loanable funds on your diagram. Show and explain the effects (in your own words) of a rise in the expected inflation rate on your diagram. ( please do not copy from other page or other people)
How does a government deficit affect the interest rate, the quantity of loanable fund, and economic growth?
How does a government deficit affect the interest rate, the quantity of loanable fund, and economic growth? Explain your reasoning in detail with appropriate diagram(s).  
1)In the IS–LM model, the impact of a decrease in government purchases in the goods market...
1)In the IS–LM model, the impact of a decrease in government purchases in the goods market has ramifications in the money market, because the decrease in income causes a(n) ______ in money ______. A) Increase; supply; B) Increase; demand; C) Decrease; supply; D) Decrease; demand. 2)If the IS curve is given by r = 18 – .01Y and the LM curve is given by r = -4 + .01Y, if the full employment level of output is 1,200, then in...
suppose the US government decrease its expenditure. What should the fed do to (a) hold money...
suppose the US government decrease its expenditure. What should the fed do to (a) hold money supply constant, (b) hold interest rate constant and (c) hold output constant? Use the IS/LM model to answer each case.
What is the impact on the loanable funds market if the quantity of loanable funds supplied...
What is the impact on the loanable funds market if the quantity of loanable funds supplied is less than the quantity demanded?
a. Use a diagram to explain the process by which a sudden decrease in households’ wealth...
a. Use a diagram to explain the process by which a sudden decrease in households’ wealth because of a decline in the stock market will, in the short run, move the economy from one long-run macroeconomic equilibrium to another. Illustrate your answer with a diagram. b. Assuming you have elected a liberal government, how would your public policymakers fix this economy? c. Would the actions you describe in your answers to question (b) cause crowding out? Explain.
For a consumer who is initially a borrower, use a budget line-indifference curve diagram to analyse...
For a consumer who is initially a borrower, use a budget line-indifference curve diagram to analyse the effect of an increase in the real interest rate. You can use one diagram to answer part (a) and (b) together. a) In your diagram, please indicate the no borrowing-and-no lending point, and indicate the optimal consumption point. [4 marks] b) In your diagram, clearly show the income and substitution effects
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT