Page 335 - Krugmans Economics for AP Text Book_Neat

Section 5 Summary

the equilibrium point (E 1 ) and the equilibrium interest 2 percentage points in the expected future inflation rate.
rate (r 1 ). How will the change in the expected future inflation rate af-
b.Now consider a new diagram with the cost of the war in- fect the equilibrium quantity of loanable funds?
cluded in the analysis. Shift the demand curve in the appro-
Interest
priate direction. Label the new equilibrium point (E 2 ) and
rate
the new equilibrium interest rate (r 2 ).
S 1
c. How does the equilibrium interest rate change in response
to government expenditure on the war? Explain. E 1
r 1 8%
21. How would you respond to a friend who claims that the gov-
ernment should eliminate all purchases that are financed by D 1
borrowing because such borrowing crowds out private invest-
ment spending?
22. Boris Borrower and Lynn Lender agree that Lynn will 0 Q 1 Quantity of
lend Boris $10,000 and that Boris will repay the $10,000 loanable funds
with interest in one year. They agree to a nominal interest
24. Using a figure similar to Figure 29.7, explain how the money
rate of 8%, reflecting a real interest rate of 3% on the loan
market and the loanable funds market react to a reduction in
and a commonly shared expected inflation rate of 5% over
the money supply in the short run.
the next year.
a. If the inflation rate is actually 4% over the next year, how 25. Contrast the short-run effects of an increase in the money sup-
does that lower-than-expected inflation rate affect Boris ply on the interest rate to the long-run effects of an increase in
and Lynn? Who is better off? the money supply on the interest rate. Which market deter-
mines the interest rate in the short run? Which market does so
b.If the actual inflation rate is 7% over the next year, how does
in the long run? What are the implications of your answers for
that affect Boris and Lynn? Who is better off?
the effectiveness of monetary policy in influencing real GDP in
23. Using the accompanying diagram, explain what will happen the short run and the long run?
to the market for loanable funds when there is a fall of

Summary 293