2. Investment A. Use a graph and a written explanation to demonstrate how the le

Question

2. Investment

A. Use a graph and a written explanation to demonstrate how the level of investment is determined. (3 points)

B. Explain what happens when the government enters the loanable funds market. (3 points)

C. When is the crowding-out effect most severe? Explain. (3 points)

D. Describe the balanced-budget multiplier, and explain what happens when both taxation and spending are increased by 100. (3 points)

E. The classical model assumes wages and prices are free to adjust to conditions. Keynes argued that prices and wages are sticky. List three reasons why wages and prices are sticky. (3 points)

Explanation / Answer

A.

level of investment is determine by rate of interest which is further determined by supply of funds and demand for loans.in figure quantity of funds are shown on ox axis and interest rate on oy axis. demand curve and supply curve meet n determine interest rate r*.

The supply for loanable funds curve slopes upward because the higher the real interest rate, the higher the return someone gets from loaning his or her money. The demand for loanable funds curve slopes downward because the higher the real interest rate, the higher the price someone has to pay for a loan.

Also investment is influenced by MEC i.e. marginal efficiency of capital

B. when a government enters loanable funds market, it increases the quantity of available loanable funds, thus shifting supply curve to the right. This happens because the government’s expenses are less than its revenues. Therefore, it has positive savings, which increases total savings. Shifting the supply of loanable funds further increases the total quantity at equilibrium, also decreases the real interest rate. This fall of the real interest rate increases net capital outflow. n causes political stability..

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