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Asked Dec 9, 2019
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Step 1

The market for loanable funds is depicted in the figure (1) below. Equilibrium is achieved at point A, where downward sloping demand curve DD and upward sloping supply curve SS for loanable funds intersect. The equilibrium interest rate and the equilibrium quantity of loanable funds is equal to i and Q respectively.

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DD Quantity of loanable funds Figure (1) interest rate

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Step 2

a.

Reduction in expenditure and rise in taxes imply contractionary fiscal policy. The demand for government borrowings will reduce due to fall in government expenditure and rise in tax revenue. With the fall in demand for government borrowings, supply of loanable funds will increase in the economy

Step 3

This will lead to a downward shift in the supply curve of loanable funds. This shown in figure (2) below. ...

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„S' в DD Quantity of loanable funds Figure (2) interest rate B,

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