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Question
Microeconomics
Posted 9 months ago
Which model would be used to show the impact of government deficit spending on the real interest rate?
Choose 1 answer:
(A) The market for loanable funds
(B) The money market
(C) The AD-AS model
D The circular flow diagram
(E) The production possibilities curve
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Answer from Sia
Posted 9 months ago
Solution
a
The market for loanable funds: This model illustrates the interaction between borrowers and lenders, determining the equilibrium interest rate based on the supply and demand for loanable funds
b
Government deficit spending: When the government borrows to finance its deficit, it increases the demand for loanable funds. This shift in demand can lead to a higher equilibrium interest rate
c
Real interest rate: The real interest rate is the nominal interest rate adjusted for inflation. An increase in government borrowing can raise the nominal interest rate, which, if inflation expectations remain constant, also increases the real interest rate
Answer
(A) The market for loanable funds
Key Concept
The market for loanable funds
Explanation
The market for loanable funds is used to show the impact of government deficit spending on the real interest rate because it directly illustrates how increased government borrowing affects the supply and demand for loanable funds, leading to changes in the equilibrium interest rate.
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