points Assume the graph below shows the market for loanable funds. Explain one SPECIFIC reason that the Demand might shift to the right. Interest rate (percent) 0 F0 Quantity of loanable funds S D
The Correct Answer and Explanation is:
One specific reason that the demand for loanable funds might shift to the right is an increase in the government budget deficit.
The demand for loanable funds represents the total borrowing in an economy, primarily driven by firms seeking to invest in new capital and the government financing its spending. When the demand curve shifts to the right, it signifies that at any given interest rate, borrowers desire a larger quantity of funds than they did previously.
An increase in the government budget deficit is a powerful catalyst for this shift. A budget deficit occurs when government spending exceeds its tax revenues. To cover this financial shortfall, the government must borrow money. It does this by issuing government securities, such as Treasury bonds, which it sells to the public, financial institutions, and foreign entities.
This act of selling bonds to raise funds means the government is actively demanding money from the pool of national savings. This government demand is added to the existing demand from private firms that borrow for investment purposes. For example, if the government embarks on a major infrastructure spending program or implements significant tax cuts without corresponding spending reductions, the deficit will grow, and its need to borrow will increase substantially.
This new, larger demand for funds from the government increases the total quantity of funds demanded at every interest rate. Graphically, this is represented by a rightward shift of the entire demand curve for loanable funds. This increased competition for a limited supply of savings will ultimately push the equilibrium interest rate higher and increase the total quantity of funds exchanged in the market.
