Answer to Question #153347 in Financial Math for k10

Question

1. a) Explain the concept of demand curve for loanable funds.

b) Explain the concept of supply curve for loanable funds.

c) Explain the effect of increasing in government expenditure through selling of bonds on interest rate in classical model.

2. Please use a graph to produce aggregate supply in classical model under the assumption of nominal wage or money wage.

3. Explain the effect of increasing in money supply on price and national income using a classical theory.

4. Explain how interest rate is determined in a classical theory.

Answer 1

a. The demand for loanable funds is downward sloping curve, the lower the interest rates the more capital a firm will demand.

b. The supply curve for loanable funds is upward sloping as interest rates go high the lower firms are willing to borrow

c.

Due to deficit spending by the government by selling bonds, the demand curve for loanable funds will shift to the right to I + (G – T).

The equilibrium rate of interest rises from r₀ to r₁

The volume of investment decreases as the volume of saving increases .

2.

In the long-run, the aggregate supply curve and aggregate demand curve are only affected by capital, labor, and technology as everything in the economy is assumed to be optimal. The aggregate supply curve is vertical showing that changes in aggregate demand only temporarily change the economy’s total output. In the long-run an increase in money will do nothing for output, but it will increase prices.

3.

The increase in the money supply is indicated by an equal increase in nominal output, or Gross Domestic Product (GDP).

Increasing money supply will lead to an increase in consumer spending causing a shift of the Aggregate Demand curve to the right.

Increased money supply causes reduction in interest rates leading to further spending and thus an increase in Aggregate Demand.

4.

In classical theory, the interest rate is determined by the intersection of savings and investments curves. The position of the saving curve depends upon the level of income; the saving curve shifts to the right as income increases and shifts to left if income decreases.