Question

The following table shows the supply and demand for loanable funds schedule in a small island country in the Caribbean at the beginning of 2016. By the end of the year however, the demand for loanable funds increases by $2 billion at each level of the real interest rate and the supply of loanable funds increased by $1 billion at each interest rate. Predict the conditions of the loanable funds market in this country, under the following two scenarios: Scenario 1 and Scenario II. Real interest rate Demand for Supply of (percent per year) loanable funds loanable funds (billions of 2009 dollars per year) 8.5 a. Scenario 1. The government budget has neither a surplus nor a deficit during the year. Under this scenario, the real equilibrium interest rate by the end of the year will be billion; private investment will be $ billion. percent: the quantity of private saving will be s b. Scenario 2. The government budget deficit reaches $1 billion. Under this scenario, the real interest rate would be percent; the quantity of private investment would be $ private saving would be $ billion. Assuming no Ricardo-Barro effect, there would be crowding out of $ billion, and the quantity of million private investment.

Answer 1

A) Neither surplus nor deficit occurs at the point where demand for loanable funds equals supply of loanable funds

This occurs when interest rate = 7%

Private saving = $7 billion

Private investment = $7 billion

B) Deficit of $1 billion occurs when demand for loanable funds exceeds supply by $1 billion

This takes place at interest rate = 6%

Private saving (supply) = $6.5 billion

Private investment (demand) = $7.5 billion

Crowding out = $1 billion investment