Q1.

(a) What is the difference between real and nominal interest rate. Assume that currently (2021) the prime interest rate is 3.45%, and inflation rate is 2.8%. Also assume that people expect that inflation will average 3.0% in 2022. Calculate ex-ante real interest rate and ex-post real interest rate based on the above information. Show all your steps/work.5 marks

(b) Using the loanable funds theory, show in properly labelled graphs, how does each of the following events affect the supply and demand for loans and the equilibrium real interest rate:

I. Wars in other countries lead to higher government spending in those countries. You need to illustrate (on the proper, well labeled graph) and explain.10 marks

II.A new technology is invented that makes firms more productive. Many firms want to buy more productive machines and computer. Higher productivity also increases people's confidence in the economy, so consumers see less need to save. You need to illustrate (on the proper, well labeled graph) and explain.10marks.