Final answer:
An increase in the government budget deficit raises the equilibrium real interest rate and increases the equilibrium quantity of loanable funds as the demand for financial capital shifts right due to government borrowing.
Step-by-step explanation:
An increase in the government budget deficit will affect the financial market in several ways. According to economic studies and financial models, when the government borrows more, the demand curve for financial capital shifts to the right (from Do to D₁). Using a supply and demand framework for the loanable funds market, an increase in demand for funds by the government causes the equilibrium real interest rate to rise and the quantity of loanable funds supplied to increase; this scenario correspondingly reduces the funds available for private investment.
In a specific scenario where the original equilibrium interest rate is at 5% with an equilibrium quantity equal to 20% of GDP, and the government increases deficit spending, the new equilibrium (E₁) will show an increase in the interest rate to 6% and an equilibrium quantity of 21% of GDP. Therefore, the answer to the question is that an increase in the government budget deficit raises the equilibrium real interest rate and increases the equilibrium quantity of loanable funds, which is option (d).