Show the changes for each scenario on a properly drawn and labeled loanable funds market graph. Then describe what happened to real interest rates and the quantity of loanable funds.
1. The government is preparing to run a deficit in order to pay for a war.
2. Due to worries about the future, Americans significantly increase their savings.
3. A prolonged recession has prompted the government to cut taxes and increase spending.
4. America is experiencing a high rate of inflation. To fight it, the government has increased taxes and cut spending.
5. Explain what crowding out is. In which scenarios could crowding out most likely occur? Explain.
The market for Loanable Fund :
In the market for the loanable funds, the demand, and supply of loanable funds determine the interest rate. At a higher rate of interest, there is less demand for the supply of loanable funds and more supply of loanable funds and vice versa.
Answer and Explanation:
(1)When the government is preparing to run a deficit to pay for the war then the demand for loanable fund increases because the government will borrow more which will shift the DL to DL1 causing the interest rate to rise from I to i1 and quantity of loanable funds increases from q to q1 as shown in figure 1.
(2)Worried about the future when America increases their savings then it means households are willing to save more and consume less which leads the supply of loanable funds to shift rightward. the interest rate decreases from i to i1 and the quantity of loanable fund increases from q to q1 as shown in figure 2.
(3) A reduction in tax rate and increased spending leads to a fall in the prices of goods and increases employment. Both will increase the aggregate demand for goods and services which makes the producer to producer to produce more goods. They will borrow money which leads demand for loanable funds to shift rightward from DL to DL1 causing the interest rate to rise from i to i1 and quantity of loanable fund increases from q to q1 .it is shown in figure 3.
(4) A increase in tax rate and cut in government spending leads to a fall in the aggregate demand which further means that no the producer will cut back the production level as supply exceeds the demand .it will lead demand for loanable fund to shift leftward from DL to DL1 causing interest rate fall from i to i1 and decrease in the quantity of loanable fund decreases from q to q1 as shown in figure 4.
(5) Crowding out is the reduction in private investment by the investor when the interest rate is increased. It mostly occurs when there is a deficit and the government tries to reduce the deficit by borrowing a large amount of money which increases the cost of borrowing. At a higher rate of interest private investors are reluctant to borrow because it is associated with the payment of a large amount of interest rate along with the principal amount.
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from Introduction to Business: Homework Help ResourceChapter 25 / Lesson 29