Answer this question in the co
Answer this question in the context of the loanable funds marketmodel. Your answers should consist of
properly labeled graphs for parts a-c. For simplicity, maintainthe assumption that the supply of loanable
funds is independent of the real interest rate.
a.
(5pts) Show the effect of an increase an in the stock oftechnology.
b.
(5pts) Show the effect of a change in consumer preferences whichresult in them becoming more
impatient and myopic.
c.
(5pts) Show the effect of a deficit financed program whichprovides investment subsidies to
businesses. Be careful on this one.
Answer:
Consider the loanable fund market in the following fig. here“DL” be the demand for loanable fund and “SL” be the supply ofloanable fund and “E1” be the equilibrium, => the equilibriumrate of interest rate is given by, “r1”.
Now, as the “stock of technology” increases, => the demandfor loanable fund will increase horizontally to “DL2”. So, giventhe supply the new equilibrium will establish at “E2”, theintersection of “DL2” and “SL”. So, we can see that as thetechnology increases, => investment increases, => the rate ofinterest rate also increases.
b).
Now, as the consumer preferences changes results they becomemore impatient, => they increase their consumption and reducesaving, => the national saving decreases implied the supply ofloanable fund decreases and shift towards the left side to“SL2”.
So, at the new equilibrium “E2” is the intersection of “DL” and“SL2”. SO, as the consumers get impatient implied the rate ofinterest increases and “savings” and “investment” decreases.
c).
Now, an introduction of deficit financed program which providesinvestment subsidies to business will increase the investmentimplied the demand for loanable fund increases.
So, here the demand for loanable fund increases to “DL2” from“DL1” and supply remain same, => given the demand theequilibrium is “E2” the intersection of “SL” and “DL2”. So, at thisnew equilibrium the rate of interest increases and investment aswell as savings both also increases.
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