Chapter 25 - Loanable funds & Riccardo-Barro effect

Question 1

What area the 2 main factors that affect the demand of loanable funds?

Answer 1

1) Real interest rate - Causes a movement along DLF curve (inversely proportional)
2) Expected profit - causes a shift of DLF curve (directly proportional)

Question 2

What 5 factors affect supply of loanable funds?

Answer 2

1) Real interest rate - causes movement along(directly proportional)
2) Disposable income (directly proportional)
3) Expected future income (Inversely proportional)
4) Wealth (Inversely proprortional)
5) Default risk (Inversely proportional)

Question 3

Describe the riccardo Barro effect

Answer 3

Holds that government budget has NO EFFECT ON INTEREST RATE OR INVESTMENT

Taxpayers are rational, can see a budget deficit, which would cause an increase in future taxes and decrease in disposable income. A decrease in disposable income means more saving, today.

Private supply of loanable funds increases to match quantity of loanable funds demanded by government.