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Investment, Saving, and
the Real Interest Rate
CHAPTER 10
CHECKPOINTS



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Problem 1
Problem 2
Problem 1
Problem 2
Problem 1
Problem 2
Problem 3 Problem 3
Checkpoint 10.1 Checkpoint 10.2
Checkpoint 10.3
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Practice Problem 1
Michael is an Internet service provider. On December 31,
2007, he bought an existing business with servers and a
building worth $400,000. During his first year of operation, his
business grew and he bought new servers for $500,000. The
market value of some of his older servers fell by $100,000.
What was Michaels gross investment, depreciation, and net
investment during 2008 and what is Michaels capital at the
end of 2008?

CHECKPOINT 10.1
Solution
Michaels gross investment during 2008 was $500,000the
market value of the new servers he bought.
Michaels depreciation during 2008 was $100,000the fall
in the market value of some of his older servers.
Michaels net investment during 2008 was $400,000.
Net investment equals gross investment minus
depreciation, which is ($500,000 $100,000).
CHECKPOINT 10.1
The capital grew during 2008 by the amount of net
investment.
Michaels net investment during 2008 was $400,000.
So that at the end of 2008, capital was
$400,000 + $400,000, which equals $800,000.
CHECKPOINT 10.1
Practice Problem 2
Lori earns $20,000 after paying her taxes.
At the beginning of 2007, Lori owned $1,000 worth of
books, CDs, and golf clubs and she had $5,000 in a
savings account at the bank.
During 2007, the interest on her savings account was
$300 and she spent $15,300 on consumption goods.
The market values of her books, CDs, and golf clubs did
not change.
How much did Lori save in 2007? What was her wealth at
the end of 2007?
CHECKPOINT 10.1
Solution
Lori saved $5,000.
Saving equals income (after tax) minus the amount
spent.
That is, Loris saving equaled $20,300 minus $15,300,
which is $5,000.
Loris wealth at the end of 2007 was $11,000the sum
of her wealth at the start of 2007 ($6,000) plus her saving
during 2007 ($5,000).

CHECKPOINT 10.1
Practice Problem 1
First Call, Inc. is a cellular phone company.
It plans to build an assembly plant that costs $10 million if
the real interest rate is 6 percent a year.
If the real interest rate is 5 percent a year, First Call will
build a larger plant that costs $12 million.
And if the real interest rate is 7 percent a year, First Call will
build a smaller plant that costs $8 million.
Draw a graph of First Calls demand for loanable funds
curve.
CHECKPOINT 10.2



Solution
The demand for loanable
funds curve is the blue
downward-sloping curve
DLF
0
and passes through the
points highlighted in the
figure.


CHECKPOINT 10.2
Practice Problem 2
First Call, Inc. is a cellular
phone company. The graph
shows its demand for loanable
funds.
First Call expects its profit to
double next year.
If other things remain the
same, explain how this
increase in expected profit
influences First Calls demand
for loanable funds.
CHECKPOINT 10.2



Solution
An increase in the expected
profit increases investment
today, which increases the
quantity of loanable funds
demanded at each real
interest rate.
The demand for loanable
funds curve shifts rightward
to DLF
1
in the figure.

CHECKPOINT 10.2



Study Plan Problem
First Call, Inc. expects its profit to double next year. If
other things remain the same, First Call _________.
A. increases the quantity of funds demanded along its
demand for loanable curve.
B. decreases its demand for loanable funds
C. increases its demand for loanable funds
D. decreases the quantity of funds demanded along its
demand for loanable curve
CHECKPOINT 10.2
Practice Problem 3
Draw a graph that illustrates how an increase in the supply
of loanable funds and a decrease in the demand for
loanable funds can lower the real interest rate and leave
the equilibrium quantity of loanable funds unchanged.
CHECKPOINT 10.2
Solution
The increase in the supply of
loanable funds shifts the supply
curve rightward.
The decrease in the demand for
loanable funds shifts the demand
curve leftward.
The real interest rate falls.
If the shifts are of the same
magnitude, the equilibrium quantity
of funds remains unchanged.
CHECKPOINT 10.2
Practice Problem 1
The table shows the demand for
loanable funds schedule and the
private supply of loanable funds
schedule.
If the government budget
surplus is $1 trillion, what are
the real interest rate, the
quantity of investment, and the
quantity of private saving?
Is there any crowding out?
CHECKPOINT 10.3



Solution
With a government budget surplus
of $1 trillion, the total supply of
loanable funds curve SLF.
The equilibrium real interest rate is
6 percent a year and the quantity
of loanable funds is $7.5 trillion.
Investment is $7.5 trillion and
private saving is $6.5 trillion.
Crowding out does not occur.
CHECKPOINT 10.3
Practice Problem 2
The table shows the demand for
loanable funds schedule and the
private supply of loanable funds
schedule.
If the government budget deficit
is $1 trillion, what are the real
interest rate, the quantity of
investment, and the quantity of
private saving?
Is there any crowding out?
CHECKPOINT 10.3



Solution
With a government budget deficit
of $1 trillion, the total supply of
loanable funds curve SLF.
The real interest rate is 8 percent
a year, investment is $6.5 trillion,
and private saving is $7.5 trillion.
Crowding out occurs because the
deficit raises the real interest rate,
which decreases investment.
CHECKPOINT 10.3
Practice Problem 3
The table shows the demand
for loanable funds schedule
and the private supply of
loanable funds schedule.
If the government budget deficit
is $1 trillion and the Ricardo-
Barro effect occurs, what are
the real interest rate and the
quantity of investment?
CHECKPOINT 10.3
Solution
If the Ricardo-Barro effect occurs,
private saving adjusts to offset the
budget deficit if $1 trillion.
The equilibrium interest rate
remains at 7 percent a year and
investment is $7 trillion.
Crowding out does not occur
because government dissaving
does not influence the real interest
rate.
CHECKPOINT 10.3