Assignment

This assignment deals with how the loanable funds market matches savers with borrowers and the impact of various market pressures on interest rates and money availability.

1. Explain how overall national savings is related to overall investment and why savings is always equal to investment.

2. Explain the relationship between these two formulas:

            Y = C + I + G + EX – IM

            S = (Y – T – C) + (T – G)

3. Explain how changes in interest rates will affect the amount of money that people save.

4. Explain how changes in interest rates and rates of return on various investment options will affect the amount of money that businesses are willing to invest to increase output.

5. Explain how the government’s tax revenue and government spending create either a budget surplus or budget deficit, and how does that difference affect the market for loanable funds?

6. Use the market for loanable funds shown in the accompanying diagram to answer the following questions.

Description: A graph showing the supply, in a red straight line rising to the right, and demand, in a straight blue line descending to the right, for loanable funds with the market interest rates on the vertical axis and money available on the horizontal axis. Initial equilibrium is at 8% interest rate and 300 million dollars.

            a. Assuming there are no external controls on interest rates, what will be the likely results on quantity of money saved, on interest rates, and on additional business investment, if the government significantly increases its borrowing to fund its growing deficit spending?

            b. At any given interest rate, a significant number of middle-class consumers decide to use their credit cards to fund additional purchases. Assuming there are no external controls on interest rates, what will be the likely results on quantity of money saved, on interest rates, and on additional business investment? Assume no change in government borrowing.

            c. At any given interest rate, many major businesses become pessimistic about the future profitability of investment spending. Assuming there are no external controls on interest rates, what will be the likely results on quantity of money saved, on interest rates, and on additional business investment? Assume no change in government borrowing.