Question

In Freedonia, there is a supply and demand for loanable funds. Suddenly, consumer confidence decreases. This decrease causes consumers to spend less of their income on goods and services. At the same time, firms’ demand for loanable funds increases due to expectations of the future. What happens to interest rates, the quantity of loanable funds, Investment, and GDP? Use graphs to explain when possible.

Answer 1

Since consumer confidence decreases, the supply curve in the market for loanable funds shifts rightward from s0 to s1. This is because as consumers spend less income on consumption their private savings increase leading to increase in national savings.

Due to future expectations the firms' demand curve shifts right from d0.

If the firms demand curve shifts to d1, that is, shift in supply> shift in demand then r falls to r1 and amount of loanable funds increases to q1.

If the firms demand curve shifts to d2, that is, shift in supply= shift in demand then r remains same r2=r0 and amount of loanable funds increases to q2.

If the firms demand curve shifts to d3, that is, shift in supply< shift in demand then r rises to r3 and amount of loanable funds increases to q3.