3.1The federal government in Australia has been running large budget deficits. The government has stated that it will take actions that will turn the budget deficits into budget surpluses over time.

aUse a market for loanable funds graph to illustrate the effect of the federal budget surpluses. What happens to the equilibrium real interest rate and the quantity of loanable funds? What happens to the level of saving and investment?

bNow suppose that households believe that surpluses will result in the government cutting taxes in the near future, as they did in the 2000s when there were budget surpluses. As a result, households increase their consumption spending in anticipation