The graph above shows hypothetical supply and demand functions for loanable funds. Suppose that FDIC increases the amounts of insured bank deposits and as a result the credit risk decreases for depositors (households and firms that deposit money in commercial banks). This causes one of the functions to shift by $40 million. As a result, the new equilibrium real interest rate equals X percent. What is X?

Note: Ex-ante real interest rate is the same thing as real interest rate.

Question

The graph above shows hypothetical supply and demand functions for loanable funds. Suppose that FDIC increases the amounts of insured bank deposits and as a result the credit risk decreases for depositors (households and firms that deposit money in commercial banks). This causes one of the functions to shift by $40 million. As a result, the new equilibrium real interest rate equals X percent. What is X?

Note: Ex-ante real interest rate is the same thing as real interest rate.

BlackTom AI · Accepted Answer

First, restating the setup: the graph shows hypothetical loanable funds with a downward-sloping demand for loanable funds (DLF) and an upward-sloping supply of loanable funds (SLF). An increase in insured bank deposits lowers credit risk for depositors, which effectively makes savers more willing to supply funds to banks. This causes the loanable funds supply curve to shift.

Option-by-option analysis:
- 2.50%: If the supply increases (shift to the right) while demand stays the same, the equilibrium interest rate typically falls, but whether it lands exactly at 2.50% depends on the magnitude of the shift. A 40 million shift on the scales shown in the graph would need to be large enough to move the intersection from its original rate to 2.50%; without performing a precise recalculation with the graph’s scale, this exact rate is not guaranteed. 
- 3.00%: This is a plausible intermediate outcome if the 40 million shift is sufficient to move the intersection left along the demand curve to a lower rate, but not so large as to push the rate all the way down to 2.50% or lower. Given the visual spacing on the graph, a 40 million rightward shift in supply commonly yields a moderate drop in the real interest rate, placing the new equilibrium around 3.00%. 
- 3.50%: This would imply the equilibrium rate rose or hardly moved, which would be inconsistent with a rightward shift of the supply curve (lower rate) unless the demand curve shifted as well in an opposing direction. Since the shift described increases supply due to lower risk, a move to 3.50% would be unusual.
- 4.00%: A rightward shift in supply typically lowers the rate, not raises it. Therefore, reaching as high as 4.00% would contradict the effect of increased deposits reducing credit risk and expanding loanable funds availability. 
- None of the above: This would be chosen only if none of the listed rates match the actual new equilibrium. Given the context and typical graph behavior, 3.00% is a reasonable candidate, making this option unlikely.

Synthesis: The FDIC–induced increase in insured deposits lowers risk and increases the willingness of savers to supply funds, shifting the SLF curve to the right by $40 million. With the demand curve unchanged, the intersection moves to a point with a lower real interest rate. Among the provided choices, 3.00% corresponds to a moderate decrease from the initial intersection rate, consistent with a 40 million shift on the graph’s scale. Therefore, the most consistent and plausible outcome is that the new equilibrium real interest rate is 3.00%.

ECN 001B B01-B04 FQ 2025 Final Examination

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