(Exhibit: Saving, Investment, and the Interest Rate 1) The economy begins in equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals desired investment, I1. What will be the new equilibrium combination of real interest rate, saving, and investment if the government increases spending, holding other factors constant? (Ch.3) Consider the market for loanable funds shown in the graph. Initially, the supply of loanable funds is $30 billion, and the demand for loanable funds is given by I(r)1.
a. Using the double drop line tool , indicate the initial equilibrium in the market for loanable funds. Label this "E1."
b. Now suppose two things occur in the market for loanable funds. First, there is an increase in technology that makes capital more productive, causing firms to increase their demand for investment by $20 billion at each interest rate. Using the infinite line tool , draw the new investment demand curve, labeling it "I(r)2." Second, consumers choose to consume less of their disposable income, resulting in a $10 billion increase in national saving. Using the infinite line tool , draw the new savings curve, labeling it "S2."
c. Using the double drop line tool , indicate the new equilibrium in the market for loanable funds. Label this "E2."