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Scenario 1: Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially,...

Scenario 1: 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   .

Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government implements a new investment tax credit.

Shift the appropriate curve on the graph to reflect this change.

The implementation of the new tax credit causes the interest rate to   and the level of investment to   .

Scenario 3: Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes.

This change in spending causes the government to run a budget   , which   national saving.

Shift the appropriate curve on the graph to reflect this change.

This causes the interest rate to   ,   the level of investment spending.

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Answer #1

Scenario 1

(a) Increase in tax rate on interest incme will decrease savings, reducing the supply of loanable funds, shifting the supply curve of loanable funds leftward.

Demand Supply Supply INTEREST RATE (Percent) Demand LOANABLE FUNDS (Billions of dollars)

(b) This change causes equilibrium interest rate to Increase and level of investment spending to Decrease.

Scenario 2

(a) Implementation of existing investment tax credit will increase business investment, shifting demand for loanable funds rightward.

Demand Supply Supply INTEREST RATE (Percent) 11 Pemand LOANABLE FUNDS (Billions of dollars)

(b) Implementation of investment tax credit causes interest rate to Increase and level of investment to Increase.

Scenario 3

(a) Increase in defense spending increases the demand for loanable funds, shifting demand curve for loanable funds rightward.

Demand Supply Supply INTEREST RATE (Percent) 11 Pemand LOANABLE FUNDS (Billions of dollars)

(b) This causes a Budget Deficit which Decreases national saving.

(b) This causes interest rate to Increase, Crowding out investment spending.

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Answer #2

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