Suppose a national early childhood education program for all preschool-aged children has been proposed. The federal government estimates that the program would cost $15 billion to implement. Assume this program would be paid for by the government borrowing, which decreases the supply of loanable funds without affecting demand. This question considers the likely effect of this government expenditure on the interest rate.

a. Draw typical demand (D₁) and supply (S₁) curves for loanable funds without the cost of the expanded pre-K programs accounted for. Label the vertical axis “Interest rate” and the horizontal axis “Quantity of loanable funds.” Label the equilibrium point (E₁) and the equilibrium interest rate (r₁). 

b. Now draw a new diagram with the cost of the expanded pre-K programs included in the analysis. Shift the demand curve in the appropriate direction. Label the new equilibrium point (E₂) and the new equilibrium interest rate (r₂). 

c. How does the equilibrium interest rate change in response to government expenditure on the expanded pre-K programs? Explain.