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part 1: Suppose the government experiences a budget deficit. Draw and explain the impact of this...

part 1: Suppose the government experiences a budget deficit. Draw and explain the impact of this on the loanable funds market.

part 2: How would the budget deficit described in part 1 impact long run economic growth? explain fully.

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Answer #1

a) an increase in the budget deficit will shift the supply of the loanable fund to the left. it will increase the interest rate in the market and decrease the available funds in the market. It will crowd out the private investment and decrease the output in the market.

b) in the long run, the supply curve is perfectly inelastic i.e. a vertical curve. if the government increase the expenditure it will lead to a 100% crowding out i.e. the investment will decrease by the exact amount of the increased government expenditure that will not have any affect in the output directly but increased interest will decrease the demand in the market

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