Question #51259

Suppose the investment demand and private saving supply curves in the market for loanable funds are given by the following equations: I = 2000 – 100r S = 500 + 100r
where r represents the real interest rate in percentage points (eg. 10% is represented by 10), and
quantities are in billions. Assume that a closed economy and that initially the government is running a
balanced budget (ie. government saving initially equals 0).
(a) What is the equation for national saving? Calculate the equilibrium interest rate, aggregate level of
investment in the economy, and the aggregate level of national saving. Illustrate in a diagram.
(b) Suppose that firms revise downward their expectations of the future cash flows from investment
projects and the result is that demand is decreased by 200 at any interest rate. What is the new
demand equation? Calculate the new equilibrium. Illustrate in your diagram.
(even if you dont do the diagrams could you at least tell me how i can go about doin it :D)

Expert's answer

I = 2000 – 100r

S = 500 + 100r

G = T, GS = 0

(a) National saving NS = S + GS = 500 + 100r

Equilibrium interest rate is:

2000 – 100r = 500 + 100r

200r = 1500

r = 7.5%

Aggregate level of investment in the economy is I = 2000 - 100*7.5 = $1250 billion,

the aggregate level of national saving is NS = I = $1250 billion.

(b) If the firms revise downward their expectations of the future cash

flows from investment projects and the result is that demand is

decreased by 200 at any interest rate.

So, the new equilibrium interest rate is:

r = (1250 - 200)/100 - 5 = 5.5%.

So, the aggregate demand curve will shift to the left and the interest rate and output will decrease.

S = 500 + 100r

G = T, GS = 0

(a) National saving NS = S + GS = 500 + 100r

Equilibrium interest rate is:

2000 – 100r = 500 + 100r

200r = 1500

r = 7.5%

Aggregate level of investment in the economy is I = 2000 - 100*7.5 = $1250 billion,

the aggregate level of national saving is NS = I = $1250 billion.

(b) If the firms revise downward their expectations of the future cash

flows from investment projects and the result is that demand is

decreased by 200 at any interest rate.

So, the new equilibrium interest rate is:

r = (1250 - 200)/100 - 5 = 5.5%.

So, the aggregate demand curve will shift to the left and the interest rate and output will decrease.

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