Chapter 17: Problem 24

For a usury law to be effective, it must set the interest rate ceiling (LO4) a) above the equilibrium rate of interest b) below the equilibrium rate of interest c) at exactly the equilibrium rate of interest

Short Answer

Expert verified

For a usury law to be effective, it must set the interest rate ceiling below the equilibrium rate of interest (Option B). This effectively limits the interest rates that lenders can charge and prevents borrowers from being exposed to excessively high interest rates. Setting the interest rate ceiling above or exactly at the equilibrium rate of interest does not provide effective control of the loan market.

Step by step solution

Understanding Usury Laws and Interest Rates

A usury law is a regulation that sets a maximum interest rate that lenders can charge borrowers. The interest rate ceiling is the highest interest rate allowed by the law. The equilibrium rate of interest is the interest rate at which the quantity of loanable funds demanded by borrowers equals the quantity supplied by lenders.

Option A: Interest Rate Ceiling Above Equilibrium Rate

If the interest rate ceiling is set above the equilibrium rate of interest, this means that lenders can still charge borrowers an interest rate that is within the market equilibrium. In this case, supply and demand for loanable funds can still reach equilibrium without any restrictions. This situation will not effectively limit the interest rates that lenders can charge, rendering the usury law ineffective in controlling the loan market.

Option B: Interest Rate Ceiling Below Equilibrium Rate

If the interest rate ceiling is set below the equilibrium rate of interest, it will restrict the interest rates that lenders can charge to borrowers. In this case, some lenders will be discouraged from supplying funds to borrowers, causing a decrease in the supply of available loanable funds. As a result, borrowers will be forced to compete for a limited number of loans, leading to a shortage of available credit. This situation effectively limits the interest rates that can be charged by lenders, making the usury law effective as it achieves its intended purpose.

Option C: Interest Rate Ceiling at Equilibrium Rate

If the interest rate ceiling is set exactly at the equilibrium rate of interest, it creates a situation where lenders cannot charge interest rates higher than the market equilibrium. However, this completely ignores factors such as economic fluctuations and changes in supply and demand for loanable funds. In such a scenario, the usury law would not be effective, as it would fail to account for changes in market conditions.

Conclusion

In order to be effective, a usury law must set the interest rate ceiling below the equilibrium rate of interest. This scenario (Option B) effectively limits the interest rates that lenders can charge and prevents borrowers from being exposed to excessively high interest rates. Setting the interest rate ceiling above or exactly at the equilibrium rate of interest does not provide effective control of the loan market.