Among the combination of events below, which one could have caused the equilibrium interest rate to fall and the equilibrium quantity of loanable funds to rise? Group of answer choices E. More individuals are middle-aged, and wealth increases. C. People have lower time preferences, and governments run larger deficits. A. Firms are more pessimistic, and governments run fewer deficits. D. People have lower time preferences, and capital is more productive. B. A baby boom begins, and investor confidence rises.
The correct answer and explanation is:
The correct answer is:
D. People have lower time preferences, and capital is more productive.
Explanation (300 words):
In the loanable funds market, the equilibrium interest rate and the quantity of loanable funds are determined by the interaction of supply (savings) and demand (investment). A fall in the equilibrium interest rate along with a rise in the quantity of loanable funds suggests that either the supply of loanable funds has increased, the demand has increased, or both, but in such a way that the increase in supply outweighs the increase in demand pressure on interest rates.
Lower time preferences mean that people value future consumption more and are thus more willing to save today. This causes the supply of loanable funds to increase, shifting the supply curve to the right. An increase in savings puts downward pressure on the interest rate and increases the quantity of loanable funds available.
Simultaneously, if capital becomes more productive, it raises the expected return on investment, prompting firms to borrow more for capital investment. This shifts the demand curve for loanable funds to the right, increasing the quantity of loanable funds demanded.
When both these effects occur:
- The supply shift reduces the equilibrium interest rate.
- The demand shift increases the equilibrium quantity of loanable funds.
- The overall effect on the interest rate depends on the relative magnitudes of these shifts, but the presence of a strong supply increase due to lower time preference tends to reduce rates.
Therefore, the combination in Option D best explains a scenario where the equilibrium interest rate falls and the equilibrium quantity of loanable funds rises—savings increase (supply shifts right), and investment demand rises due to more productive capital (demand shifts right).