Question

1. Suppose that the demand for loanable funds for car loans in the Milwaukee area is $10 million per month at an interest rate of 10 percent per year, $11 million at an interest rate of 9 percent per year, $12 million at an interest rate of 8 percent per year, and so on

a. If the supply of loanable funds is fixed at $15 million, what will be the equilibrium interest rate?

b. If the government imposes a usury law and says that car loans cannot exceed 3 percent per year, how big will the monthly shortage (or excess demand) for car loans be?

c. What if the usury limit is raised to 7 percent per year?

Interest rate on Loan	Demand for Loanable Funds	Supply of Loanable Funds
10%	$10 million	$15 million
9%	$11 million	$15 million
8%	$12 million	$15 million
7%	$13 million	$15 million
6%	$14 million	$15 million
5%	$15 million	$15 million
4%	$16 million	$15 million
3%	$17 million	$15 million
2%	$18 million	$15 million
1%	$19 million	$15 million

2. Suppose that the interest rate is 4 percent. What is the future value of $100 four years from now? How much of the future value is total interest?

	Beginning Period Value	Yearly Interest	Future Value
Year 1	100
Year 2
Year 3
Year 4

Total Interest = Future Value – Initial Value

Answer 1

a)

Loanable funds demanded is equal to Loanable funds supplied at interest rate of 5%. So, equilibrium interest rate is 5%

b)

If interest rate =3%

Loanable funds demanded=$17 million

Loanable funds supplied=$15 million

Shortage=Loanable funds demanded-Loanable funds supplied=17-15=$2 million

c)

If maximum permitted interest rate is 7%.

It is above equilibrium interest rate. So, it is non-binding. Market will remain at equilibrium at 5%

2)

	Beginning Period Value	Yearly Interest	Future Value
Year 1	$100.00	100*4%=$4.00	$104.00
Year 2	$104.00	104*4%=$4.16	$108.16
Year 3	$108.16	108.16*4%=$4.33	$112.49
Year 4	$112.49	112.49*4%=$4.50	$116.99

Future Value in 4 years from now=$116.99 (Refer above table)

Total Interest=Future Value-Initial Value=116.99-100=$16.99