Question 4 Suppose there is a shortage in the market for loanable funds. Is the

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Question 4 Suppose there is a shortage in the market for loanable funds. Is the interest rate above or below its equilibrium level? How do desired saving and desired investment at this interest rate compare? Question 5 In Jan 2013, Project A requires initial investment of $5000 and generates total payment of $6000 in Jan 2014. Also, in Jan 2014, Project B requires $500 initial investment and generates $750 in Jan 2017. What is the average annually compounding rate of return of these two projects?

Explanation / Answer

4. In case of shortage of funds in lonable market this means demand for lonable funds is more than supply. In this case interest rate will increase.So interest rate is greater than equilibrium level of interest. Since interest rate is higher than equilibrium this means desired savings will be more and desired investment will be less . The cost of investment is interest rate if interest rate is higher this would mean less investment will be undertaken. Similarly the opportunity cost of current consumption is interest rate. Since interest rate is higher than equilibrium so people will postpone current consumption and increase savings.

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