Question: To explore crowding-out, let's set up a simple loanable funds market in initial equilibrium.
a. Draw a graph showing initial equilibrium in the loanable funds market at $800 million and an interest rate of 4%. Label your initial supply and demand curves as S1 and D1.
b. Now assume that the government increases spending by $100 million that is entirely deficit-financed. Show the new equilibrium in the loanable funds market. (Note: there is a range of possible numerical answers for this question. You should choose one number and then be sure the rest of your answer is consistent with this number.)
c. Write the new equilibrium interest rate and quantity of loanable funds in the blanks below: New interest rate: _______ New quantity of loanable funds: _______
d. If we assume there was no government debt prior to the fi scal stimulus, determine the new quantities for the blanks below: Savings: ______ Investment: _______ Government spending: _______
e. How much did private consumption change as a result of the change in the quantity of savings?