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1. First, briefly describe the loanable funds market. 2. Next, in the domestic economy the...

Question:

1. First, briefly describe the loanable funds market.

2. Next, in the domestic economy the government is running a budget deficit and needs to borrow money. Describe what will occur in the loanable funds market. (Note: what happens to the equilibrium interest rate and equilibrium quantity of loanable funds)?

3. Draw a graph to help answer the question and be sure to provide the intuition behind what is happening and also discuss any interesting observations or outcomes.

Macroeconomics:

The branch of economics that studies the economy as a whole and deals with the aggregates in an economy is known as macroeconomics. It provides various indicators that help to measure the national income of the country, the gross domestic product, unemployment and the inflation in the economy

Answer and Explanation:

1) The loanable funds market explains the interaction of the savers and the borrowers in the economy. The savers supply the loanable funds and the borrowers demand the loanable funds. When the real interest rate is adjusted then the market is in equilibrium that is the amount of saving is equal to the amount of borrowing. The loanable funds model is a variation of the market model.

2) In the domestic economy when the government is running a budget deficit then this causes a decline in the private investment spending and when there is a need to borrow money than the demand for the loanable fund's increases. Therefore, the equilibrium interest rate increases and the quantity of loanable funds also rise.

3)In the graph above, the supply and the demand curves of loanable funds are shown. At point E, the market for loanable funds is in equilibrium. With the rise in the demand for the loanable funds, the real interest rate and the quantity of the loanable funds increases and the economy moves from point E to F.

Crowding out is caused due to the government budget deficit and the need to borrow money. The amount of crowding out that occurs is the change in the quantity of loanable funds. The outcome is that the quantity of loanable funds increases due to the increase in the demand and the real interest also increases.


Learn more about this topic:

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Loanable Funds: Definition & Theory

from Introduction to Business: Homework Help Resource

Chapter 25 / Lesson 29
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