Three students have each saved $1000. Each has an investment opportunity in which he or she can invest up to $2000. The rates of return on the students' investment projects are: Harry: 5% Ron: 8% Hermione: 20%.
a) If borrowing and lending is prohibited, so each student uses only his or her own saving to finance his or her own project, how much will each student have a year later when the projects pay their returns?
b) Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate r. What would determine whether a student would choose to be a lender or a borrower in this market?
c) Among those three students, what would be the quantity of loanable funds supplied and quantity demanded at an interest rate of 7%? At 10%?
d) At what interest rate would the loanable funds market among the three students be in equilibrium? At this interest rate, which students would borrow and which would lend? e) At the equilibrium interest rate, how much does each student have a year later after the loans have been repaid and the projects pay their returns? Compare your answers to part
a). Who benefits from the market? Is anyone worse off?