Suppose your roommate’s parents open a college savings account to pay for her college expenses.
Opening a college savings account
shifts the demand curve for loanable funds to the left, decreases the neutral interest rate and decreases the equilibrium quantity of loanable funds.
shifts the supply curve of loanable funds to the right, decreases the neutral interest rate and increases the equilibrium quantity of loanable funds.
has no effect on the loanable funds market.
shifts the demand curve for loanable funds to the right, increases the neutral interest rate and increases the equilibrium quantity of loanable funds.
The correct answer and explanation is :
The correct answer is:
Shifts the supply curve of loanable funds to the right, decreases the neutral interest rate, and increases the equilibrium quantity of loanable funds.
Explanation:
To understand why this is the correct answer, let’s break down the situation in terms of the loanable funds market.
In the loanable funds market, there are two main forces at play:
- Demand for loanable funds: This comes from individuals or institutions seeking loans for investment (e.g., businesses borrowing for expansion or people borrowing to finance large purchases).
- Supply of loanable funds: This comes from people who save and deposit money into financial institutions (like banks), which is then available to be loaned out.
College Savings Account:
When your roommate’s parents open a college savings account to save for her college expenses, they are effectively increasing their savings. In doing so, the supply of loanable funds in the market increases. Here’s how:
- Increase in Savings: The money being deposited into the college savings account represents an increase in personal savings. As savings increase, the overall supply of funds available for lending rises.
- Supply Curve Shift: The increased savings shift the supply curve of loanable funds to the right. This is because there is more money available for banks and other financial institutions to lend.
- Neutral Interest Rate: The increase in the supply of loanable funds tends to decrease the neutral interest rate. The neutral interest rate is the rate at which the amount of funds people want to borrow equals the amount of funds people want to lend. With more funds available (due to increased savings), the interest rate falls to balance the supply and demand for loanable funds.
- Equilibrium Quantity: As the supply of loanable funds increases, the equilibrium quantity of loanable funds (the total amount of money being borrowed and lent) also increases. More money is available to borrowers, and the lower interest rates make borrowing more attractive.
Conclusion:
Thus, the opening of a college savings account shifts the supply curve of loanable funds to the right, decreases the neutral interest rate, and increases the equilibrium quantity of loanable funds.