Free-Response Question

1. Question

   
   

   1. Draw a correctly labeled graph of the market for loanable funds. On your graph, indicate each of the following:

      
      

      1. the equilibrium interest rate, labeled r₁

         
         
      
      

      2. the equilibrium quantity of loanable funds, labeled Q₁

         
         
      
      

      
      

      
      
   
   

   2. Use your graph from (a) to show how an increase in government spending affects the loanable funds market. On the graph, indicate each of the following:

      
      

      1. the new equilibrium interest rate, labeled r₂

         
         
      
      

      2. the new equilibrium quantity of loanable funds, labeled Q₂

         
         
      
      

      
      

      
      
   
   

   3. Explain how the new interest rate (r₂) affects the level of real GDP. (5 points)

      
      
   
   

   Rubric for FRQ (5 points)

   1 point: The vertical axis is labeled “Interest rate (r ),” the horizontal axis is labeled “Quantity of loanable funds (Q_LF),” the demand for loanable funds curve is labeled and downward-sloping, and the supply of loanable funds curve is labeled and upward-sloping.

   1 point: Showing the equilibrium interest rate on the vertical axis to the left of where the supply and demand curves intersect, and showing the equilibrium quantity of loanable funds on the horizontal axis below where the supply and demand curves intersect

   1 point: Showing a shift of the demand for loanable funds to the right

   1 point: Showing the new equilibrium interest rate and quantity of loanable funds using the old supply curve and the new demand curve

   1 point: The higher interest rate decreases investment spending (and interest-sensitive consumption spending) and therefore reduces real GDP.