Chapter 25, Problem 6P

To determine

The likely effect of government expenditure on the interest rate.

Concept introduction:

Loanable Funds Market: It is an imaginary market which illustrates the market result of the demand for funds which are generated by borrowers and supply of funds which are provided by the lenders.

Demand for Loanable Funds: It is represented by a downward sloping curve which indicates that as the interest rate increases the demand for loanable funds decreases and vice versa.

Supply for Loanable Fund: It is represented by the s curve that's slopes upward which means that as the interest rate increases the supply of loanable fund also increases and vice versa.

Equilibrium Interest Rate: In the loanable fund market, the point where demand curve and supply curve intersect each other gives the equilibrium interest rate.

Factors that help in shifting demand for loanable funds are:

Change in Perceived Business Opportunities: when the businessman in a market is opportunistic and optimistic about the condition of market then the demand curve shifts rightward otherwise left ward.

Change in Government Borrowing: when there is a budget deficit it means government spends more than the tax revenue it has.