The current market rate of interest is 10 percent. At that rate of interest, businesses borrow $300 billion per year for investment and consumers borrow $50 billion per year to finance purchases. The government is currently borrowing $150 billion per year to cover its budget deficit.

a. Derive the market demand for loanable funds, and show how investors and consumers will be affected if the budget deficit increases to $250 billion per year. Draw a graph to show your conclusion.

b. Assuming taxpayers do not anticipate an increase in the future market rate of interest due to the increase in budget deficit, show the impact of the increase in the budget deficit on the market for loanable funds.

c. How would your conclusion differ if taxpayers fully anticipate future tax increases to offset the increase in the budget deficit?

d. Do you think the Ricardian Equivalence is realistic?