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Three students have each saved $1,000 and each can invest up to $2,000. Here are the rates of return on their investment projects: Harry 5%, Ron 8%, and Hermione 20%.
a.) If borrowing and lending is prohibited, so that each student uses only their savings to finance their project, how much will each student have a year later when the project pays its return? At what interest rate would the loanable funds market amoung these three students be in equilibrium? At this interest rate, which students would borrow, and which students would lend?
b.) Compare your answers to those you have in part
(a). Who benefits from the existence of the loanable funds market- the borrowers or the lenders? Is anyone worse off?
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