Idle Factory Capacity
The question
After years of heavy factory building, manufacturers in Verrand find that much of their plant and machinery now sits unused, and managers report they can fill every order they expect for years ahead without installing any additional equipment. Assume household saving at each real interest rate is unchanged. Show the effect of this situation in Verrand's 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.
Idle Factory Capacity: the worked answer
On the Loanable Funds Market graph, Demand for loanable funds shifts left.
Why Demand for loanable funds shifts left
Firms borrow in the loanable funds market to finance purchases of new physical capital. With existing plant already sitting unused, few additional capital projects are worth undertaking at any real interest rate, so firms want to borrow less at every rate and the demand for loanable funds shifts to the left. Household saving is unchanged by assumption, so the supply of loanable funds stays put.
What happens to the equilibrium
The equilibrium real interest rate falls and the equilibrium quantity of loanable funds decreases.
The mistake students make on this one
Many students shift supply right because idle capacity sounds like spare resources piling up and waiting to be used. Unused machines are physical capital, not lendable funds, and nothing in the stem changed how much income households make available to lenders; what changed is how many projects firms want to finance.
On exam day
Ask what the story does to the number of profitable capital projects. When firms already own all the capacity they need, their borrowing schedule moves left even though not one word of the stem is about saving.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Demand for loanable funds shifts left 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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