Question 5 Chapter 13 The market for loanable funds and government policy
The following graph shows the market for loanable funds. For each of the given s
... [Show More] cenarios, adjust the
appropriate curve on the graph to help you complete the questions that follow. (Note: You will not be graded
on any changes you make to the graph.)
Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income
earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is an increase in the tax rate on
interest income, from 20% to 25%.
Shift the appropriate curve on the graph to reflect this change.
This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the
market for loanable funds to and the level of investment spending to . INTEREST RATE (Percent)
fall
fall
Explanation: Close Explanation
Saving is the source of the supply of loanable funds. Taxing a larger share of the interest income
earned on saving will discourage saving at each interest rate, causing the supply of loanable funds to
shift to the left. There is a shortage of loanable funds at the initial interest rate. With more willing
borrowers than lenders, the lenders will be able to raise the interest rate they charge for loans. As the
interest rate rises, the quantity of loanable funds demanded decreases. The equilibrium interest rate
rises, and the equilibrium quantity of loanable funds saved and invested falls.
Explanation: Close Explanation
The repeal of the previously existing investment tax credit will discourage firms from investing at every
interest rate. The policy causes the demand for loanable funds to shift to the left. There is a surplus of
loanable funds at the initial interest rate. As lenders lower their interest rates to attract borrowers, the
quantity of loanable funds supplied decreases. The equilibrium interest rate falls, and the equilibrium
quantity of loanable funds saved and invested falls.
Points: 1 / 1
An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant
time period. Suppose the government repeals a previously existing investment tax credit.
Shift the appropriate curve on the graph to reflect this change.
The repeal of the previously existing tax credit causes the interest rate to and the level of saving
to .
Points: 1 / 1
Initially, the government's budget is balanced, then the government responds to the conclusion of a war by
significantly reducing defense spending without changing taxes.
This change in spending causes the government to run a budget surplus , which increases national
saving.
Points: 1 / 1
Shift the appropriate curve on the graph to reflect this change.
fall increasing
Explanation: Close Explanation
The government moves from a budget balance to a budget surplus when it reduces government
spending without changing taxes. This increase in public saving causes national saving to rise. Since
saving is the source of supply in the market for loanable funds, the increase in public saving causes the
supply of loanable funds to shift to the right. The result is a surplus of loanable funds at the initial
interest rate. As lenders lower their interest rates to attract borrowers, the quantity of loanable funds
demanded increases. The equilibrium interest rate falls, and the equilibrium quantity of loanable funds
saved and invested rises.
Crowding out is the reduction in the level of investment that occurs when the government borrows
to finance a budget deficit.
This causes the interest rate to , the level of investment spending.
Points: 1 / 1 [Show Less]