Question

Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students’ investment projects:
Student Return
(Percent)
Harry 5
Ron 8
Hermione 20
Assume borrowing and lending is prohibited, so each student uses only personal saving to finance his or her own investment project.

Complete the following table with how much each student will have a year later when the project pays its return.

Student Money a Year Later
(Dollars)
Harry ________
Ron ________
Hermione ________
Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate Three students have each saved $1,000. Each has an .

A student would choose to be a borrower in this market if his or her expected rate of return is ___(Less or Greater)____ than .

Suppose the interest rate is 7 percent.

Among these three students, the quantity of loanable funds supplied would be $_______________, and quantity demanded would be $________

Now suppose the interest rate is 10 percent.

Among these three students, the quantity of loanable funds supplied would be $_______, and quantity demanded would be$_________

At an interest rate of __________, the loanable funds market among these three students would be in equilibrium. At this interest rate,_____(Harry, Hermione, Ron, Ron and Harry, Hermione and Ron)_____ would want to borrow, and ____(Harry, Hermione, Ron, Ron and Harry, Hermione and Ron)_____ would want to lend.

Suppose the interest rate is at the equilibrium rate.

Complete the following table with how much each student will have a year later after the investment projects pay their return and loans have been repaid.

Student Money a Year Later
(Dollars)
Harry ________
Ron ________
Hermione ________
True or False: Only borrowers are made better off, and lenders are made worse off.

True

False

Answer 1

Answer:

Student Money a Year Later:

Harry = Money saved + student return * money saved = $1000 + (5% * 1000) = $1050

Ron = Money saved + student return * money saved = $1000 + (8% * 1000) = $1080

Hermione = Money saved + student return * money saved = $1000 + (20% * 1000) = $1200

Explanation:

a) Student Money a Year Later:

Harry = Money saved + student return * money saved = $1000 + (5% * 1000) = $1050

Ron = Money saved + student return * money saved = $1000 + (8% * 1000) = $1080

Hermione = Money saved + student return * money saved = $1000 + (20% * 1000) = $1200

b) A  student would choose to be a borrower in this market if his or her expected rate of return is greater than the interest rate and lends if his or her expected rate of return is less than the interest rate

c) If interest = 7%, Harry would want to lend while Ron and Hermione would want to borrow. The quantity of funds demanded would be $2,000, while the quantity supplied would be $1,000. If interest = 10%, only Hermione would want to borrow. The quantity of funds demanded would be $1,000, while the quantity supplied would be $2,000.

d) At an interest rate of 8%, the loanable funds market among these three students would be in equilibrium. At this interest rate Hermione would want to borrow, and Harry would want to lend.

e) At equilibrium:

Harry =  $1000 + (8% * 1000) = $1080

Ron = $1000 + (8% * 1000) = $1080

Hermione = $2,000(1 + 0.20) – $1,000(1 + 0.08) = $2,400 – $1,080 = $1,320

Both borrowers and lenders are better off. No one is worse off