These are original Marlbridge practice questions, not past exam questions. All questions use Valdoria, a fictional country whose currency is the valda (VD); all data are fictional and in VD billion per year. The rubrics are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. Notation: Y = GDP, C = consumption, T = net taxes, G = government purchases. When you draw a graph, put the real interest rate on the vertical axis and the quantity of loanable funds on the horizontal axis.
Question 1 (multiple choice · foundation)
In a closed economy, Y = 500, C = 320, T = 90 and G = 110. What is national saving?
- (A) 70
- (B) 90
- (C) 110
- (D) 180
Answer and explanation
Answer: (A). Private saving = Y − T − C = 500 − 90 − 320 = 90. Public saving = T − G = 90 − 110 = −20. National saving = 90 + (−20) = 70. Check: Y − C − G = 500 − 320 − 110 = 70.
- (B) is private saving only. It ignores the government’s deficit, which reduces national saving.
- (C) gets the sign of public saving wrong: 90 − (−20). A deficit is negative public saving and is added, so national saving falls.
- (D) is Y − C. It leaves out government purchases.
Question 2 (multiple choice · core)
Valdoria’s loanable funds market is shown below.
| Real interest rate | 2% | 3% | 4% | 5% | 6% |
|---|---|---|---|---|---|
| Quantity demanded | 80 | 70 | 60 | 50 | 40 |
| Quantity supplied | 40 | 50 | 60 | 70 | 80 |
If the real interest rate is 3%, which statement is correct?
- (A) There is a surplus of VD 20 billion, and the real interest rate will fall.
- (B) There is a shortage of VD 20 billion, and the real interest rate will rise.
- (C) There is a shortage of VD 20 billion, and the real interest rate will fall.
- (D) There is a shortage of VD 70 billion, and the real interest rate will rise.
Answer and explanation
Answer: (B). At 3%, borrowers want 70 but savers offer only 50, a shortage of 70 − 50 = 20. Borrowers compete for the scarce funds, so the real rate rises towards the equilibrium of 4%, where both quantities are 60.
- (A) reverses the gap. A surplus would need quantity supplied above quantity demanded, which happens only above 4%.
- (C) has the right gap but the wrong adjustment. A shortage pushes the price of loans up, not down.
- (D) uses the quantity demanded (70) as the size of the shortage instead of the gap between the two quantities.
Question 3 (multiple choice · core)
Valdoria’s government introduces an investment tax credit for firms that buy new equipment. All else equal, what happens in the loanable funds market?
- (A) Supply increases; the real interest rate falls and the quantity of loanable funds rises.
- (B) Demand increases; the real interest rate rises and the quantity of loanable funds rises.
- (C) Demand increases; the real interest rate rises and the quantity of loanable funds falls.
- (D) Demand decreases; the real interest rate falls and the quantity of loanable funds falls.
Answer and explanation
Answer: (B). The tax credit lowers the cost of investing, so firms want to borrow more at every real interest rate. Demand shifts right along an unchanged supply curve, so both the real rate and the equilibrium quantity rise.
- (A) treats the tax credit as a change in saving. It changes the incentive to borrow, not to save.
- (C) has the right shift but the wrong quantity. A rightward demand shift along an upward-sloping supply curve raises the quantity.
- (D) has the shift in the wrong direction. The credit makes investment more attractive.
Question 4 (multiple choice · core)
Valdoria is an open economy. National saving is VD 240 billion and the net capital inflow is VD 35 billion. What is domestic investment?
- (A) VD 35 billion
- (B) VD 205 billion
- (C) VD 240 billion
- (D) VD 275 billion
Answer and explanation
Answer: (D). In an open economy, investment = national saving + net capital inflow = 240 + 35 = 275.
- (A) is the net capital inflow alone. Domestic saving also funds investment.
- (B) subtracts the inflow. A net inflow adds foreign funds, so investment can exceed national saving.
- (C) uses the closed-economy identity and ignores foreign lending.
Question 5 (constructed response · core)
Valdoria’s loanable funds market is in equilibrium. The government then cuts taxes without changing its spending, and borrows to finance the larger budget deficit.
(a) Draw a correctly labelled graph of the loanable funds market. Label the equilibrium real interest rate r₁ and the equilibrium quantity Q₁. (b) On your graph, show the effect of the extra government borrowing. Label the new equilibrium real interest rate r₂. (c) What happens to the quantity of private investment? Explain. (d) Explain why the vertical axis shows the real interest rate rather than the nominal interest rate.
Model answer and suggested Marlbridge rubric
(a) Vertical axis: real interest rate. Horizontal axis: quantity of loanable funds. A downward-sloping demand curve (D) and an upward-sloping supply curve (S) cross at r₁ and Q₁.
(b) Demand-side view: the government is an extra borrower, so demand shifts right to D₂. The new equilibrium has a higher real rate, r₂ > r₁. Supply-side view (also acceptable): the larger deficit lowers public saving, so supply shifts left to S₂ and r₂ > r₁.
(c) Private investment falls. The government’s borrowing competes for the available saving and raises the real interest rate. At the higher rate, fewer investment projects earn more than the cost of borrowing, so firms borrow and invest less.
(d) Savers and borrowers care about purchasing power. A saver’s reward is how many more goods the repayment buys, and a firm compares the real return on capital with the real cost of borrowing. Inflation changes the nominal rate without changing these real trade-offs.
| Point | What earns it |
|---|---|
| 1 | Correctly labelled graph: real interest rate and quantity of loanable funds on the axes, D down, S up, r₁ and Q₁ shown |
| 1 | Demand shifts right (or supply shifts left) with r₂ above r₁ |
| 1 | Private investment falls |
| 1 | Explains through the higher real interest rate making borrowing for investment less attractive |
| 1 | Explains that savers and borrowers decide on the basis of purchasing power (real returns and costs) |
A graph with “interest rate” alone on the vertical axis does not earn the first point. Either shift in (b) is acceptable, but the label must match the curve that moved.
Question 6 (constructed response · core)
The table shows Valdoria’s loanable funds market. “New supply” shows saving after households decide to save more at every real interest rate.
| Real interest rate | Quantity demanded | Quantity supplied | New supply |
|---|---|---|---|
| 1% | 140 | 50 | 80 |
| 2% | 130 | 70 | 100 |
| 3% | 120 | 90 | 120 |
| 4% | 110 | 110 | 140 |
| 5% | 100 | 130 | 160 |
| 6% | 90 | 150 | 180 |
(a) Identify the original equilibrium real interest rate and quantity of loanable funds. (b) Using the original supply, state whether there is a surplus or a shortage at 5%, give its size, and explain how the market returns to equilibrium. (c) Identify the new equilibrium after households save more. (d) By how much does investment change? Explain why the real interest rate had to change for this to happen.
Worked solution and suggested Marlbridge rubric
(a) 4% and VD 110 billion (quantity demanded = quantity supplied = 110).
(b) At 5%, quantity supplied is 130 and quantity demanded is 100: a surplus of VD 30 billion. Lenders cannot lend all their funds, so they accept a lower rate. As the real rate falls, borrowing rises and saving falls until the quantities are equal at 4%.
(c) 3% and VD 120 billion (quantity demanded = new supply = 120).
(d) Investment (the quantity demanded) rises from 110 to 120, an increase of VD 10 billion. Firms’ demand curve did not shift. They borrow more only because the extra saving pushed the real interest rate down from 4% to 3%, which made more investment projects worth funding.
| Point | What earns it |
|---|---|
| 1 | Original equilibrium 4% and VD 110 billion |
| 1 | Surplus of VD 30 billion at 5% |
| 1 | Rate falls because lenders compete to lend; quantities move to equality |
| 1 | New equilibrium 3% and VD 120 billion |
| 1 | Investment rises by VD 10 billion, explained as a movement along demand caused by the lower real rate |
Accept values carried forward from an earlier error.
Question 7 (constructed response · stretch)
In one year, Valdoria (an open economy) has Y = 1,200, C = 780, T = 250 and G = 280. The net capital inflow is VD 40 billion.
(a) Calculate private saving and public saving. (b) Calculate national saving and domestic investment. (c) Foreign lenders lose confidence and withdraw funds, so the net capital inflow falls. Using the loanable funds market, explain the effect on the real interest rate and on domestic investment.
Model answer and suggested Marlbridge rubric
(a) Private saving = 1,200 − 250 − 780 = VD 170 billion. Public saving = 250 − 280 = −VD 30 billion (a deficit).
(b) National saving = 170 + (−30) = VD 140 billion (check: 1,200 − 780 − 280 = 140). Investment = 140 + 40 = VD 180 billion.
(c) Fewer foreign funds are lent into Valdoria, so the supply of loanable funds shifts left. At the old real rate there is now a shortage, so the real interest rate rises. At the higher real rate firms borrow less, so the equilibrium quantity of loanable funds and domestic investment fall.
| Point | What earns it |
|---|---|
| 1 | Private saving VD 170 billion and public saving −VD 30 billion |
| 1 | National saving VD 140 billion |
| 1 | Investment VD 180 billion, adding the net capital inflow |
| 1 | Supply of loanable funds shifts left, so the real interest rate rises |
| 1 | Investment falls because the higher real rate reduces borrowing |
Accept values carried forward from (a). In (c), a demand shift earns no credit: the change comes from lenders, not borrowers.
How did you do?
- Q1, Q4 or Q7(a)–(b) wrong: re-read “National saving and investment” and Worked example 1 in the study guide.
- Q2 or Q6(a)–(b) wrong: revisit “Equilibrium and disequilibrium” and Figure 1.
- Q3, Q6(c)–(d) or Q7(c) wrong: revisit “What shifts the curves” and Worked example 2.
- Q5 wrong: revisit Worked example 3 and Figure 2, and check your axis labels.
Then tick off the topic checklist.