Part (a) The diagram below illustrates the impact of a decrease in government spending on interest rates and investment, assuming that private savings depend positively on the interest rate: Interest Rate ^ | S1 | | | | | | r1 -----------------|---------------------- S2 | | | | | | | | | +----------------------------> Loanable Funds I1 I2 The initial equilibrium is at the intersection of S1 (supply of loanable funds) and the initial demand curve, with interest rate r1 and investment I1. A decrease in government spending shifts the demand curve for loanable funds to the left. With a positively sloped supply curve (S2), the new equilibrium occurs at a lower interest rate and higher investment level (I2). Part (b) A decrease in government spending reduces the demand for loanable funds, lowering the interest rate. The lower interest rate encourages higher investment spending. National saving increases due to the decrease in government borrowing. Private saving also increases as the lower interest rate induces more saving by consumers. The increase in private and national saving outweighs the decrease in government borrowing, resulting in a higher overall supply of loanable funds