Idle Plants, Forced Saving
The question
Manufacturers across Willowmere finish a long building spree and now hold far more plant and machinery than they expect to need for years, so almost none of them plan to install additional equipment. In the same year, a new national pension law takes effect that requires every worker to place a fixed share of each paycheck into a retirement account, well above what most workers had been putting aside on their own. Show the effect of these two developments in Willowmere's loanable funds market. Show the effect on the Loanable Funds Market graph.
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Idle Plants, Forced Saving: the worked answer
On the Loanable Funds Market graph, Demand for loanable funds shifts left and Supply of loanable funds shifts right.
Why Demand for loanable funds shifts left and Supply of loanable funds shifts right
Firms borrow in this market to finance new physical capital, and with plants already sitting idle very 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 left. The supply of loanable funds is the flow of household saving made available to borrowers, and a law that routes a fixed share of every paycheck into retirement accounts, above what workers were saving voluntarily, raises the amount saved at every real interest rate, so the supply of loanable funds shifts right. Both shifts push the same way on the vertical axis, since weaker borrowing and stronger lending each drive the price of funds down, so the equilibrium real interest rate definitely falls. The two shifts conflict on the horizontal axis, because the retreat in investment borrowing lowers the volume of funds changing hands while the larger pool of saving raises it. The equilibrium quantity of loanable funds is therefore indeterminate: it falls if the leftward shift of demand is larger than the rightward shift of supply, rises if the shift of supply is larger, and is unchanged if they are equal. The stem gives no basis for that comparison.
What happens to the equilibrium
The equilibrium real interest rate definitely falls, while the equilibrium quantity of loanable funds is indeterminate because it depends on whether the drop in investment borrowing or the rise in mandated saving is the larger shift.
The mistake students make on this one
The characteristic error is treating both outcomes as determinate, typically as "the real interest rate falls and the quantity of loanable funds rises," on the reasoning that cheaper borrowing must mean more lending happens. Only the rate is determinate. Demand shifting left cuts the quantity and supply shifting right raises it, and the stem never ranks the two, so the quantity has no sign. Students also frequently mistake the idle machinery for spare funds and shift the saving side for it: unused equipment is physical capital, and what it actually changes is how many projects firms want to finance.
On exam day
Draw both shifts on the graph before you commit to any conclusion, because reading the new equilibrium off a picture with two curves moved is the only reliable way to see which axis is pinned down and which one can go either way depending on the relative size of the shifts.
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 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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