Question

1. Consider the US loanable funds market. For each of the following separate scenarios, draw a graph to show how the equilibrium interest rate and equilibrium quantity of loanable funds changes.

1. Banks impose more regulations and make it more difficult for firms to borrow.
2. Productivity of machines decreases.
3. Households are less confident about the economy, they expect a recession will come soon.

Answer 1

In following three graphs, D0 and S0 are initial demand and supply curves for loanable funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds Q0.

(i)

When borrowing becomes more difficult, it decreases firms' businessinvestment, which reduces the demand for loanable funds. Demand curve shifts leftward, decreasing interest rate and decreasing quantity of lanable funds.

In following graph, decrease in demand shifts D0 leftward to D1, intersecting S0 at point B with lower interest rate r1 and lower quantity of loanable funds Q1.

50 Do 9160 ए

(ii)

Decrease in productivity reduces business profitability, so firms reduce investment. It reduces the demand for loanable funds. Demand curve shifts leftward, decreasing interest rate and decreasing quantity of lanable funds.

In following graph, decrease in demand shifts D0 leftward to D1, intersecting S0 at point B with lower interest rate r1 and lower quantity of loanable funds Q1.

50 Do 9160 ए

(iii)

When households expect a future recession, they consume less and save more. This increases the supply of loanable funds. Supply curve shifts rightward, decreasing interest rate and increasing quantity of lanable funds.

In following graph, increase in supply shifts S0 rightward to S1, intersecting D0 at point B with lower interest rate r1 and higher quantity of loanable funds Q1.

وه رک A مر B ر Do و ر9 وو