Loanable Funds Market drawing worksheet
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Loanable Funds Market drawing worksheet · problem 1 of 4
The government of Alta begins running a budget deficit and enters the loanable funds market, issuing new bonds to borrow the funds it needs. Assume that private saving at each real interest rate is unchanged. Show the effect of the government's borrowing in the loanable funds market.
Draw the initial equilibrium, show the change, and label every curve and both axes. Mark the new equilibrium.
Explain your reasoning:
Loanable Funds Market drawing worksheet · problem 2 of 4
Households in the economy of Alta, expecting higher incomes in the future, increase current consumption and reduce the portion of income they save at each real interest rate. Assume firms' desired investment spending at each real interest rate is unchanged. Show the effect of this change in the loanable funds market.
Draw the initial equilibrium, show the change, and label every curve and both axes. Mark the new equilibrium.
Explain your reasoning:
Loanable Funds Market drawing worksheet · problem 3 of 4
The government of Alta enacts an investment tax credit that lowers the cost to firms of purchasing new capital equipment. Assume household saving behavior is unchanged. Show the effect of the tax credit in the loanable funds market.
Draw the initial equilibrium, show the change, and label every curve and both axes. Mark the new equilibrium.
Explain your reasoning:
Loanable Funds Market drawing worksheet · problem 4 of 4
In the economy of Marovia, firms grow confident that consumer demand will be strong for years to come, so they plan to expand factories and buy new equipment. Assume household saving behavior at each real interest rate is unchanged. Show the effect of this change in the loanable funds market.
Draw the initial equilibrium, show the change, and label every curve and both axes. Mark the new equilibrium.
Explain your reasoning:
Loanable Funds Market drawing worksheet: answer key
1. Financing the Deficit: demand shifts right
Borrowers make up the demand for loanable funds, and the government's bond issuance makes it a new borrower in the market. At every real interest rate, the total quantity of funds demanded is now higher because government borrowing is added to private investment borrowing. The demand for loanable funds shifts to the right, while the supply of saving is unchanged by assumption.
The equilibrium real interest rate rises and the equilibrium quantity of loanable funds increases.
Watch for: Many students shift the supply of loanable funds left instead, reasoning that government borrowing takes funds away from private borrowers. The government here is a borrower, not a lender, so its new bonds add to the borrowing side; the crowding out of private investment shows up as the higher interest rate reducing the quantity of funds firms borrow along their own unchanged demand schedule, not as a leftward shift of supply.
2. Household Saving Behavior: supply shifts left
Household saving is the source of the supply of loanable funds. When households consume more and save a smaller portion of income at each real interest rate, fewer funds are made available to borrowers. The supply of loanable funds shifts to the left, while firms' demand for funds is unaffected because their desired investment at each interest rate has not changed.
The equilibrium real interest rate rises and the equilibrium quantity of loanable funds decreases.
Watch for: A frequent wrong answer is to shift the demand for loanable funds right because households are spending more, importing the logic of the product market where extra consumption raises demand. The demand curve here is borrowing to finance capital, and the stem holds firms' investment fixed; what actually changed is how much income households release to lenders.
3. Investment Tax Credit: demand shifts right
The investment tax credit raises the after-tax return on new capital, so more investment projects become profitable for firms at every real interest rate. Firms borrow in the loanable funds market to finance this investment, so the demand for loanable funds shifts to the right. Household saving decisions are unchanged by assumption, so the supply of funds stays put.
The equilibrium real interest rate rises and the equilibrium quantity of loanable funds increases.
Watch for: The classic wrong answer is to shift demand left, reasoning that if the credit makes each machine cheaper then firms need to borrow fewer dollars to buy the equipment they already planned on. A credit raises the after-tax return on capital, so projects that were not worth financing before now clear the hurdle; firms buy more equipment rather than buying the same equipment for less, and total borrowing rises.
4. Wave of Business Optimism: demand shifts right
Firms are the borrowers in the loanable funds market, and greater optimism about future sales makes more investment projects appear profitable at every real interest rate. To finance this planned investment, firms want to borrow more, so the demand for loanable funds shifts to the right. Household saving is unchanged by assumption, so the supply of funds stays put.
The equilibrium real interest rate rises and the equilibrium quantity of loanable funds increases.
Watch for: Some students shift supply right, treating confident and soon-to-be-profitable firms as having more money to lend out. Firms sit on the borrowing side of this model; expected future sales change how much financing they want, not the pool of household saving available to lend.