Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.

Use the market for loanable funds shown in the accompanying diagram to explain what happens to private savings, private investment spending, and the interest rate if each of the following events occur. Assume that there are no capital inflows or outflows.

The graph shows demand and supply curves labeled D and S respectively. The horizontal axis is labeled ‘Quantity of loanable funds’, and the vertical axis is labeled ‘Interest rate’. The supply curve S is an upward sloping line that originates at the intersection of the horizontal and vertical axes. The demand curve D is a downward sloping line that originates from the vertical axis and extends to a point on the horizontal axis. The point of intersection of S and D is labeled E and corresponds to a point Q1 on the horizontal axis and rate r1 on the vertical axis.

a. If the government reduces the size of its deficit to zero there will be a(n) in the of loanable funds. Reducing deficits to zero will cause interest rates to .

Correct! For further review, see section, "The Loanable Funds Market."
Sorry, if the government reduces its deficit to zero, there will be a decrease in the demand for loanable funds equal to the reduction in the size of the deficit. In response to the decrease in demand, the interest rate falls. For further review see section, “The Loanable Funds Market.”
If the government reduces the size of its deficit to zero there will be a(n) ______ in the ______ of loanable funds. Reducing deficits to zero will cause interest rates to ______.
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Use the market for loanable funds shown in the accompanying diagram to explain what happens to private savings, private investment spending, and the interest rate if each of the following events occur. Assume that there are no capital inflows or outflows.

The graph shows demand and supply curves labeled D and S respectively. The horizontal axis is labeled ‘Quantity of loanable funds’, and the vertical axis is labeled ‘Interest rate’. The supply curve S is an upward sloping line that originates at the intersection of the horizontal and vertical axes. The demand curve D is a downward sloping line that originates from the vertical axis and extends to a point on the horizontal axis. The point of intersection of S and D is labeled E and corresponds to a point Q1 on the horizontal axis and rate r1 on the vertical axis.

b. At any given interest rate, if consumers decide to save more and the government budget remains unchanged there will be a(n) in the of loanable funds. This will cause the interest rate to .

Correct! For further review, see section, "The Loanable Funds Market."
Sorry, if consumers decide to save more, there will be an increase in the supply of loanable funds (a rightward shift). The increase in the supply of loanable funds reduces the equilibrium interest rate.For further review see section, “The Loanable Funds Market.”
At any given interest rate, if consumers decide to save more and the government budget remains unchanged there will be a(n) ______ in the ______ of loanable funds. This will cause the interest rate to ______.

Use the market for loanable funds shown in the accompanying diagram to explain what happens to private savings, private investment spending, and the interest rate if each of the following events occur. Assume that there are no capital inflows or outflows.

The graph shows demand and supply curves labeled D and S respectively. The horizontal axis is labeled ‘Quantity of loanable funds’, and the vertical axis is labeled ‘Interest rate’. The supply curve S is an upward sloping line that originates at the intersection of the horizontal and vertical axes. The demand curve D is a downward sloping line that originates from the vertical axis and extends to a point on the horizontal axis. The point of intersection of S and D is labeled E and corresponds to a point Q1 on the horizontal axis and rate r1 on the vertical axis.

c. At any given interest rate, if businesses become very optimistic about the future profitability of investment spending and the government budget remains unchanged then the of loanable funds will . This will cause interest rates to .

Correct! For further review, see section, "The Loanable Funds Market."
Sorry, higher investment spending at any given interest rate leads to an increase in the demand for loanable funds (rightward shift). The increase in the demand for loanable funds shifts the demand curve to the right and raises the equilibrium interest rate. For further review see section, “The Loanable Funds Market.”
At any given interest rate, if businesses become very optimistic about the future profitability of investment spending and the government budget remains unchanged then the ______ of loanable funds will ______. This will cause interest rates to ______.
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