AP® Macroeconomics · Free response

Government borrowing in Corvel: the real interest rate, investment and the capital stock

write it first, then score yourself point by point

Short free-response question · four-function calculator · 5 points · about 12 minutes

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The question

Name: ______________________   Date: ____________   Government borrowing in Corvel: the real interest rate, investment and the capital stock (5 points)

The government of Corvel, an invented country, runs a large budget deficit and pays for it by borrowing.

  1. (A) Draw a correctly labeled graph of Corvel's loanable funds market. Show the effect of the government's borrowing on the real interest rate, and label the new real interest rate r2. [3 points]

  2. (B) Explain how the change in the real interest rate affects private investment in Corvel. [1 point]

  3. (C) Identify the effect of the change in private investment on the growth of Corvel's capital stock and potential output over time. [1 point]