1. Using the loanable funds theory, show in a graph how each of the following events affects the supply and demand for loans and the equilibrium real interest rate:

a. A war leads the government to increase spending on the military. (Assume taxes do not change.)
b. Wars in other countries lead to higher government spending in those countries.
c. Someone invents a new kind of computer that makes firms more productive. Many firms want to buy the computer. Higher productivity also increases people's confidence in the economy, so consumers see less need to save.
d. The same things happen as in part (c). In addition, increased confidence in the economy raises net capital inflows.

2. Suppose the real interest rate rises. Using the loanable funds theory, discuss whether this event is likely to reflect good economic news or is a sign of trouble.

3. Suppose that discount brokers make bonds more liquid. It becomes quick and inexpensive to sell bonds. In the liquidity preference theory, how does this development affect money demand and the interest rate?

4. Suppose again that discount brokers make bonds more liquid. What should the central bank do if it doesn't want the interest rate to change? Explain your answer.

5. Suppose a Treasury bond costs $100 and promises a payment of $105 in 1 year. A bond from the Acme Corporation costs $100 and promises $107 in a year. Assume that Acme pays the $107 with probability p. With probability 1 - p, Acme defaults and pays nothing. What are likely values of p?