Question

Use a diagram of the loanable funds market to illustrate the effect of the following events on the equilibrium interest rate and investment spending. a. An economy is opened to international movements of capital, and a net capital inflow occurs.

b. Retired people generally save less than working people at any interest rate. The proportion of retired people in the population goes up.

Short answer

a. The effect on net capital inflow is shown in the below diagram:

b. The effect of an increase in retired people population is shown below:

Step-by-step solution

Explanation for part (a)

When a country opens to the international market, it attracts new investors to invest in the country; this leads to an increase in the capital inflow of the country.When capital inflow increases, the supply of loanable funds also increases. This is shown below:

The supply curve shift from S₀ to S_1, and the number of loanable funds also increases from Q₀ to Q₁; the interest decreases from r₀ to r₁. The economy attains a new equilibrium, changing from E₀ to E₁.

Thus, investment spending increases with the fall in the interest rate.

Explanation for part (b)

The increase in the retired number of people will reduce the savings, and thus the supply of loanable funds will decrease.The supply curve will shift inward from S₁ to S₀, and the quantity will slip from Q₁ to Q₀. As a result, the interest rate will be higher. It will increase from the initial interest rate of r₁ to r₀.

Thus, investment spending will reduce with an increase in interest rate.