Sign Up

Sign Up to our social questions and Answers Engine to ask questions, answer people’s questions, and connect with other people.

Sign In

Login to our social questions & Answers Engine to ask questions answer people’s questions & connect with other people.

Forgot Password

Lost your password? Please enter your email address. You will receive a link and will create a new password via email.

You must login to ask a question.

Please briefly explain why you feel this question should be reported.

Please briefly explain why you feel this answer should be reported.

Please briefly explain why you feel this user should be reported.

Share & grow the world's knowledge!

We want to connect the people who have knowledge to the people who need it, to bring together people with different perspectives so they can understand each other better, and to empower everyone to share their knowledge.

The following graph shows the loanable funds market. For each of the given scenarios

The market for loanable funds and government policy

The following graph shows the loanable funds market. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Consider each scenario separately by returning the graph to its starting position when moving from one scenario to the next. (Note: You will not be graded on any changes you make to the graph.)

Scenario 1: Individual Retirement Accounts (IRAs) allow workers to shelter a portion of their income from taxation. Suppose the maximum annual contribution to accounts of this type is $6,000 per person. Now suppose there is an increase in the maximum contribution, from $6,000 to $9,000 per year.

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

This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to____ fall____ and the level of investment spending to ____increase____

Explanation 
Saving is the source of the supply of loanable funds. Allowing households to shelter more saving from income taxes will encourage more saving at each interest rate, causing 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.

Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases new capital within some 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_____fall_____ and the level of investment to_____fall_____

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.

Scenario 3: 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.

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

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

Explanation
The government moves from a balanced budget 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. Thus, crowding out does not occur in this scenario.

Related Posts

Leave a comment

Latest News & Updates

QuizlyPro Latest Articles

McMann Solutions Inc. knowingly violates the Clean Water Act by discharging hazardous pollutants into a nearby river

McMann Solutions, Inc., knowingly violates the Clean Water Act by discharging hazardous pollutants into a nearby river. McMann Solutions is subject to a. neither a fine or imprisonment. b. fines but no criminal charges or imprisonment because a corporation cannot ...

Farm and Ranch Supply Co. discovers a cache of an unknown herbicide in a back corner of its warehouse

Farm and Ranch Supply Co. discovers a cache of an unknown herbicide in a back corner of its warehouse. Farm and Ranch repackages the product, relabeling it as “Farmer’s Friend” and stating on the label and in advertisements that it ...

Tiger Stripe owns and operates gasoline filling stations. Patrick’s Trucking delivers fuel to Tiger Stripe’s storage facility on a regular basis

Tiger Stripe owns and operates gasoline filling stations. Patrick’s Trucking delivers fuel to Tiger Stripe’s storage facility on a regular basis. On one occasion, Patrick fails to pay proper attention to his truck when he is unloading fuel into Tiger ...

Explore Our Blog