Answer the following question, using the chart provided below. Circle your final answer to each question. Consider the market for loanable funds in the United States during 1996. Loanable funds are funds made available by banks for the purpose of providing loans. Banks obtain such funds from private savings deposits. Thus, individuals supply the money for these funds through their savings deposits, and banks demand such money.

Interest rate                              Quantity Demanded ($Billion)               Quantity Supplied

4%                                                 10                                                                      2

6%                                                   8                                                                       4

8%                                                   6                                                                       6

10%                                                 4                                                                       8

12%                                                2                                                                       10

14%                                                1                                                                       11

a) Draw the graph representing the market for loanable funds. Label the demand curve D1 and the supply curve S1.

b) Given D1 and S1, if the banks charged 10% interest on loans, what would the situation be in the market. Is there a shortage or a surplus? By how much? How should price respond to this situation?

c) Given D1 and S1, what is the equilibrium rate of interest in this market.

d) Suppose, in order to finance the budget deficit, the US Treasury increases its borrowing of loanable funds by $4 billion at each interest rate. Draw the new demand curve, labeling it D2. What is the new equilibrium interest rate and equilibrium quantity of loans made?

e) Given you answer in (d), what do you think happens to the market for new homes? Draw the graph representing the new housing market. Show what happens to new home prices and equilibrium quantity of homes resulting from the US Treasury’s action.

f) Refer back to the initial supply and demand curves (S1, D1). Now in relation to these curves, suppose that the United States government lowers the income tax rate charged to income earned by savings. How does this affect the loanable funds market? Does supply or demand change? Draw the new curve that results from this tax rate decrease, labeling the new curve X. What happens to equilibrium quantity of loans and the equilibrium interest rate?