5 Steps to a 5 AP Macroeconomics 2019

132 ❯ Step 4. Review the Knowledge You Need to Score High

Other popular macroeconomics textbooks, including the one that your

teacher probably chose to use, place the government in the supply curve.

The supply curve represents the sum of both private saving (from house-

holds) and public saving from the government. If the government has a

budget deficit, public saving is negative and the supply of loanable funds

shifts leftward. If the government has a budget surplus, public saving is

positive and the supply of loanable funds shifts rightward.

Suppose the government is running a budget deficit and public saving

is negative. Figure 10.6 shows that a leftward shift of the supply curve

increases the interest rate in the market for loanable funds and decreases

the quantity of loanable funds both invested and saved.

So it doesn’t matter if your textbook (or teacher) treats crowding out

as a leftward shift in supply of, or as a rightward shift in demand for, loan-

able funds. As long as you can see (or show) the impact of government

budget deficits as a higher interest rate and lower private investment, you

will score highly on those exam questions.

Interest Rate

Loanable Funds ($)

S 0

D

i %

$F

S 1

Net Export Effect

If the government is borrowing to conduct fiscal policy, the resulting increase in inter-

est rates has a similar crowding out effect on net exports through foreign exchange rates.

Again, this is a topic that is addressed in a later chapter, but the basics can be described

here. If you are a German, a Malaysian, or a Brazilian and you see interest rates rising in the

United States, this higher interest rate makes the United States an attractive place to invest

your money and earn higher interest payments. However, you need dollars to purchase a

U.S. security (e.g., a U.S. Treasury bond). The increased demand for dollars drives up the

“price” of a dollar, which is measured in how many euros, ringgits, or reals it takes to buy

a dollar on the currency market. The market for U.S. dollars is illustrated in Figure 10.7,

where the price is measured in the number of euros it takes to acquire one dollar.

Figure 10.6

KEY IDEA