-In the figure above, the SLF curve is the supply of loanable funds curve and the PSLF curve is the private supply of loanable funds curve. If there is no Ricardo-Barro effect and the government now runs a balanced budget,
A) the equilibrium interest rate is 4 per cent and investment is $1.8 trillion.
B) the interest rate will increase from 4 per cent to 6 per cent.
C) the equilibrium interest rate is 6 per cent and investment is $1.6 trillion.
D) there is shortage of investment funds of $0.4 trillion.
E) there is a surplus of investment funds and the interest rate falls to 4 per cent.

Question

-In the figure above, the SLF curve is the supply of loanable funds curve and the PSLF curve is the private supply of loanable funds curve. If there is no Ricardo-Barro effect and the government now runs a balanced budget,
A) the equilibrium interest rate is 4 per cent and investment is $1.8 trillion. 
B) the interest rate will increase from 4 per cent to 6 per cent. 
C) the equilibrium interest rate is 6 per cent and investment is $1.6 trillion. 
D) there is shortage of investment funds of $0.4 trillion. 
E) there is a surplus of investment funds and the interest rate falls to 4 per cent.

Quizplus · Accepted Answer

When the government runs a balanced budget, it means that it is not borrowing from the loanable funds market, which would shift the supply curve of loanable funds (SLF) to the left (as depicted by the PSLF curve). Without the Ricardo-Barro effect, which posits that private saving adjusts to offset government borrowing or saving, the supply of loanable funds is higher, leading to a lower equilibrium interest rate and higher investment. However, since the question does not provide details about shifts in curves or initial conditions beyond the absence of the Ricardo-Barro effect and a balanced budget, the correct answer is inferred based on the given options. Option C suggests an equilibrium interest rate of 6 per cent and investment of $1.6 trillion, which could reflect the new equilibrium without government borrowing, assuming the PSLF represents the new supply curve without government intervention.

-In the Figure Above, the SLF Curve Is the Supply