1. Examine each of the following scenarios in the market for loanable funds. Exp

Question

1. Examine each of the following scenarios in the market for loanable funds. Explain the impacts on private savings, private investment spending, and the rate of interest under each of the following events. Assume the economy is autarky (closed) and it does not have trade and capital transactions (flows) with foreign countries.

a. Assume the government balances its budget and reduces the size of its deficit to zero. (Refer to the graph below). What is its impact on private savings, private investment spending, and the rate of interest?

b. Suppose the consumers decide to save more money, at the given rate of interest. Then assume the budget is balanced and the deficit is zero (refer to the graph below). What is the impact of this scenario on private savings, private investment spending and the rate of interest?

Explanation / Answer

a. It reduces the interest rate, private savings and private investment spending is lowered because the funds available to be borrowed are decreased.

b. The interest rate decreases, private savings increases and private investment spending decline because the amount available for borrowing is considerably reduced.

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