Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students’ investment projects: Student Return (Percent) Harry 5 Ron 8 Hermione 20 Assume borrowing and lending is prohibited, so each student uses only personal saving to finance his or her own investment project. Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate r . A student would choose to be a lender in this market if his or her expected rate of return isless than r . Suppose the interest rate is 6 percent. Among these three students, the quantity of loanable funds supplied would be $_____, and quantity demanded would be $______. Now suppose the interest rate is 12 percent. Among these three students, the quantity of loanable funds supplied would be $ ______, and quantity demanded would be $ _____.

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At the 6 percent rate, the quantity of loanable funds supplied by the three students would be $3,000 (the total of their personal savings). The quantity demanded would be $2,000, as Ron and Harry would not want to lend at a rate that is less than their return; they would keep their savings invested in more profitable ventures. At the 12 percent rate, the quantity of loanable funds supplied would remain at $3,000, since the students cannot borrow money due to the prohibition on borrowing and lending. However, the quantity of loanable funds demanded would increase to $3,000, as all three students would choose to be lenders in this market, given their expected returns are all below the 12 percent rate.
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