1. In the summer of 2010, Congress passed a far-reaching financial reform to prevent another financial crisis like the one experienced in 2008-2009. Consider the following possibilities: (A.) Suppose that, by requiring firms to comply with strict regulations, the bill increases the cost investment. On a well-labeled graph, show the consequences of the bill on the market for loanable funds. Be sure to specify changes in the equilibrium interest rate and level of saving and investment. What are the effects of the bill on long-run economic growth? (B.) Suppose, on the other hand, that by effectively regulating the financial system, the bill increases savers’ confidence in the financial system. Show the consequences of the policy in this situation on a new graph, again nothing changes in the equilibrium interest rate and level of saving and investment. Again evaluate the effects on long-run growth.
2. A company has an investment project that would cost $10 million today and yield a payoff of $15 million in 4 years. (A.) Should the firm undertake the project if the interest rate is 11 percent? 10 percent? 9 percent? 8 percent? (B.) Can you figure out the exact cutoff for the interest rate between profitability and nonprofitability?
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