Question

At the interest rate of 5%, the people of the country of Rupertopia are willing to lend $10,000 to local business, while local businesses are willing to borrow $20,000. When the interest rate rises to 10%, the quantity of loans supplied increases to $20,000, while the quantity of loans demanded drops to $10,000. Because the people of Rupertopia are suspicious of outsiders, all financial transactions happen between locals. Assume both supply and demand curves for loanable funds are linear.

Suppose the town council of Rupertopia, instead of running their usual balanced budget, decides to borrow $5,000 from the townspeople to build a new park. Assume the supply of loanable funds stays constant. Given this information and holding everything else constant, which of the following statements is true:

I. The equilibrium level of private investment spending in Rupertopia will decrease

II. The equilibrium level of savings in Rupertopia will increase

III. The equilibrium interest rate will increase after the town council implements the decision.

Select one:

a. Only I. and III are true

b. Only I. is true

c.  I. II. and III. are all true

d. Only II. and III. are true

Answer 1

option D

in the figure before the demand for funds by town council , equilibrium is at point e where the interest rate = OR1 an quantity of funds = OQ1 given by intersection of supply curve S and the demand for loanable fund curve shown by I.

After the demand for funds by town council , the demand curve becomes , I+ (G-T) where G-T = deficit of the government such that new equilibrium is at point f where the interest rate = OR2 an quantity of funds = OQ2. So equilibrium interest rate has increased and the level of savings has also increased .At OR2 interest rate ,the level of investment is OQ3 so the level of private investment has   decreased.