(11 points) For the next question you will use the Loanable Funds Model, and will evaluate the effects of government borrowing under two scenarios. The first scenario assumes that private savings does not depend on the interest rate. The second scenario assumes that private savings does depend on the interest rate, i.e. consumers will save a larger portion of their disposable income as interest rates rise. Hint: these two scenarios result in differently drawn savings curves.

(a) (6 points) Using the loanable funds model and assuming that that consumption, and hence private savings, DO depend on the interest rate negatively, demonstrate the impact of a decrease in government spending on interest rates and investment. Your response to this requirement must contain a diagram of the Loanable Funds Model. Be sure to label all parts clearly.

(b) (5 points) Using the graph you developed in part (a) above, explain your results for investment, the interest rate, national saving, and private saving. Please keep your explanation to 100 words or less.