Question

During the most recent recession, some economists argued that the change in the interest rates that comes about due to deficit spending implied in the demand and supply of financial capital graph would not occur. A simple reason was that the government was stepping in to invest when private firms were not. Using a graph, explain how the use by government in investment offsets the deficit demand.

Short answer

When there's the reduction within the private investment, it results in fall within the demand for capital and hence, the curve shifts to the left. Now, these leftward shifts would be remunerated by the increase within the government spending which further results in rightward shift back again.

Diagrammatically, it may be shown as done below:

Step-by-step solution

Concept Introduction  

The budget balance is the values of government revenue and spending. When spending is higher than earning, the budger is said to be in deficit. When the earning of the government i higher than expenses incurred, budget is said to be in surplus.

Explanation of Solution 

Initially, the horizontal axis shows the number of monetary capital and vertical axis shows the rate. The equilibrium appears at the intersection of cash supplied and demanded at E0. With the autumn within the investment by private sector, the demand for capital increases from D0 to D1 with the increase of rate from R to R 1 and rise within the quantity of economic capital from Q to Q 1. But the private investment will not be done so it's needed to stay the rate fixed which may be done by shifting the provision curve to the proper from S 0 to S 1. This further shifts the rate to E 1 to E 2.

The change within the rate of interest would remain the identical as seen from E0 to E2. This can be because the private sector would unable to try and do so as government sector is curious about investing. Rate is that the rate which needs to be reimbursed for the loan borrowed.