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Using the market for loanable funds, graphically illustrate, and upload an image, of what happens to...

Using the market for loanable funds, graphically illustrate, and upload an image, of what happens to interest rates and investment if the government budget goes from a surplus to a deficit.

Be sure to carefully label all components of your figure.

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Answer #1

Given that the government budget goes from a surplus to a deficit. This implies that public saving is turning negative and government will borrow from the market. As borrowing is increased, the demand for loanable funds increases. Demand curve shifts right. This raises the market rate of interest. Some of the private investment declines due to higher interest rate. But overall there is an increase in both interest rate and total investment. New equilibrium is established at E1.

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