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Suppose that there are two groups of consumers who demand home loans from financial institutions:

• a high income group with demand function:

Demand for funds = 140 - 8(rate of interest on loans);

• a low income group with demand function:

Demand for funds = 120 - 8(rate of interest on loans),

where the interest rate is in %. For example, if the interest rate on loans is 4% then the demand of the high income group is 108.

The supply of funds to the home loan market is:

Supply of funds = -10 + 20(rate of interest on deposits).

Suppose that the home loan market is perfectly competitive so that in the absence of regulation the rate of interest on loans equals the rate of interest on deposits (in equilibrium).

Round your answers to two decimal places.

c) (6 points) Now suppose that the rationing mechanism is to allocate loans to the borrowers who value them most (i.e. have the highest willingness to pay). The government decides to impose a ceiling of 6.5% on the rate of interest on deposits and on the rate of interest on loans.

What amount of loans does each group of borrowers receive? What amount of consumer surplus is received by high income and low-income borrowers? Show them on graphs. What is the effect on the lenders' surplus? Calculate the deadweight loss due to the government intervention (if any).

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