Suppose that the equilibrium interest rate in the U.S. market for loanable funds is 4% prior to any international capital flows in the United States. The equilibrium interest rate in the Chinese market for loanable funds is 8%. If lenders in both nations believe that loans to foreigners are just as good as loans to their own citizens, capital will flow from _____, making interest rates _____ in China and _____ in the United States.

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Question: Suppose that the equilibrium interest rate in the U.S. market for loanable funds is 4% prior to any international capital flows in the United States. The equilibrium interest rate in the Chinese market for loanable funds is 8%. If lenders in both nations believe that loans to foreigners are just as good as loans to their own citizens, capital will flow from _____, making interest rates _____ in China and _____ in the United States.
Answer options:
- the United States to China; rise; fall
- China to the United States; fall; rise
- China to the United States; rise; fall
- the United States to China; fall; rise

Analysis of each option:
Option 1: the United States to China; rise; fall
This choice proposes that funds move from the United States to China. Given the initial rates (U.S. 4%, China 8%), capital would not logically flow from the lower-rate country to the higher-rate country; investors seek higher returns, not lower. If funds did move U.S. to China, the U.S. supply of loanable funds would decrease (pushing rates up), and China’s supply would increase (pushing rates down). The stated effects (U.S. rate rise and China rate fall) are inconsistent with the direction of flow implied here, making this option incorrect.
Option 2: China to the United States; fall; rise
Here, money is said to flow from China to the United States. If capital leaves China (where the rate is higher at 8%), the domestic supply of loanable funds in China would shrink, pushing China’s rate upward. Concurrently, the United States would receive more funds, increasing its supply and pushing the U.S. rate downward. The predicted pattern (China rate fall and U.S. rate rise) contradicts the usual outcome in this setup, so this option is incorrect.
Option 3: China to the United States; rise; fall
This option also has capital moving from China to the United States, but it predicts China’s rate rising and the United States’ rate falling. As explained above, China would experience a tightening of its loanable funds supply, pushing its rate up, while the United States would experience an increase in funds, pushing its rate down. This aligns with the typical mechanism of capital flowing from a high- to a low-rate country, but the direction of the rate effects is reversed in this phrasing, making the eventual pairing (rise in China, fall in U.S.) plausible and consistent with the flow direction described. This is the correct conceptual outcome.
Option 4: the United States to China; fall; rise
This choice mirrors Option 1 in flow direction but asserts the opposite pattern of rate changes (U.S. rate falls, China rate rises). Given the initial disparity (China higher at 8%), the flow would not be from the United States to China, so the rate implications are also inconsistent with the flow. Therefore, this option is incorrect.

Summary:
- Only Option 3 correctly matches the logic that capital moves from the higher-rate country (China, 8%) to the lower-rate country (United States, 4%), which would raise China’s rate and lower the United States’ rate.
- All other options either reverse the direction of capital flow or assign the opposite direction of changes in interest rates, which contradicts the standard loanable funds mechanism under these conditions.

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