Question

Suppose people become very scared, leading to an increase in exogenous demand for loans. Describe, in words, what will happen in the loan market. Also, describe how this will affect the goods market.

Answer 1

Increase in demand of loan as people are very scared will shift demand curve of loans in loanable market to its right which tends to raise rate of interest from "i" to "i1" as well as quantity of funds traded from "Q" to "Q1".

Rise in rate of interest will reduce investment level as it will raise cost of borrowing for people which tends to reduce aggregate demand in economy as investment level and aggregate demand have positive relationship with each other. It will shift demand curve to its left in long run which reduce price level from P to P1.