Retiring National Debt
The question
The government of Ceyland collects more in tax revenue than it spends and uses the resulting budget surplus to buy back and retire outstanding government bonds. Assume firms' desired investment at each real interest rate is unchanged. Show the effect of this action in the loanable funds market. Show the effect on the Loanable Funds Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Retiring National Debt: the worked answer
On the Loanable Funds Market graph, Supply of loanable funds shifts right.
Why Supply of loanable funds shifts right
A budget surplus represents public saving, which adds to the total pool of funds available to lend. When the government retires debt, it returns funds to the market and stops competing for private saving, so more funds are supplied to borrowers at every real interest rate. The supply of loanable funds shifts to the right, while firms' investment demand is unchanged by assumption.
What happens to the equilibrium
The equilibrium real interest rate falls and the equilibrium quantity of loanable funds increases.
The mistake students make on this one
The usual competing answer is to shift demand left on the grounds that the government is borrowing less. That treatment fits a government that cancels planned new bond issues, but this stem has the government handing cash back to bondholders out of a surplus, which is public saving entering the lending side of the market.
On exam day
Name the result, not just the shift. When the government adds to national saving the real interest rate falls and firms borrow more along an unchanged demand curve, which is crowding in, and free-response rubrics regularly award a point for using that term correctly.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Supply of loanable funds shifts right and every other curve on the Loanable Funds Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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