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Use the loanable funds market to illustrate the effect of the following events on the equilibrium....

Use the loanable funds market to illustrate the effect of the following events on the equilibrium. Illustrate the effects on the interest rate and quantity of investment-savings (explain thoroughly):

At any given interest rate, businesses become very optimistic about the future profitability of investment spending (assume the budget balance is zero).

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Answer #1

If businesses become optimistic about the future profitability of investment spending, they expand their business and increase their business investment. Since investment represents the demand for loanable funds, higher investment increases the demand for loanable funds. It shifts demand curve rightward, increasing interest rate and increasing quantity of loanable funds (investment and savings).

In following graph, D0 and S0 are initial demand and supply curves of loanable funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds (savings/investment) Q0. D0 shifts right to D1, intersecting S0 at point B with higher interest rate r1 and higher quantity of loanable funds (savings/investment) Q1.

80 YDO DI 81 8

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