Figure 26-5. Figure 26-5 shows the loanable funds market for a closed economy. Interest Rate 7% 6% 5% D S $75 $100 $125 Loanable Funds Refer to Figure 26-5. Starting at point A, a reduction in government spending would cause a) the quantity of loanable funds traded to increase to $125 and the interest rate to fall to 5% (point D). b) the quantity of loanable funds traded to decrease to $75 and the interest rate to rise to 7% (point E). c) the quantity of loanable funds traded to increase to $125 and the interest rate to rise to 7% (point C). Refer to Figure 26-5. Starting at point A, a reduction in government spending would cause a) the quantity of loanable funds traded to increase to $125 and the interest rate to fall to 5% (point D). b) the quantity of loanable funds traded to decrease to $75 and the interest rate to rise to 7% (point E). c) the quantity of loanable funds traded to increase to $125 and the interest rate to rise to 7% (point C). d) the quantity of loanable funds traded to decrease to $75 and the interest rate to fall to 5% (point B).

In the loanable funds market, if firms become more optimistic about future profitability, then the a demand for loanable funds will increase, interest rates will increase, and private sector investment spending will increase. b demand for loanable funds will decrease, interest rates will decrease, and the equilibrium quantity of borrowing will decrease. c supply of loanable funds will increase, interest rates will decrease, and the equilibrium quantity of borrowing will increase. d supply of loanable funds will increase, interest rates will increase, and private sector investment spending will increase.

Homework (Ch 23) 5. Impact of budget deficits The following graph shows the loanable funds market in the United States. It plots both the demand (D) for loanable funds and the supply (S) of loanable funds. At the current equilibrium, the government is operating with a balanced budget. Assume now that the financial industry is close to bankruptcy and the U.S. government decides to implement a bailout plan of several billion dollars without increasing taxes, causing a budget deficit. Show the effect of the budget deficit on the market for loanable funds by shifting the demand (D) curve, the supply (S) curve, or both. INTEREST RATE LOANABLE FUNDS Based on this model, the budget deficit leads to D $ 6 m D/ in the level of investment and in the interest rate.

Assume the country’s government increased spending and as a result, the nation ran a deficit. Explain how the increase in government spending will affect real interest rates and show the change on the loanable funds market graph.