Again the following graph shows the market for loanable fund

Again, the following graph shows the market for loanable funds. Initially, the government\'s budget is balanced. The government then responds to the conclusion of a war by significantly reducing defence spending without changing taxes. This change in spending causes the government to run a budget_. Shift the appropriate curve(s) on the following graph to show the impact of the change in the government\'s budget balance.

Solution

there will be a budget deficit.

national savings will fall

real interest rates will rise

investment spending will then rise.

thus national savings will reduce. Now in order to increase the investment spending, the government will float bonds with higher rate of interest thus the demand for loanable funds will rise, pulling up overall investments.