Question

Attempts: Keep the Highest: /4 5. The market for loanable funds and government policy The following graph shows the market for loanable funds. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Treat each scenario separately by resetting the graph to its original state before examining the effect of each individual scenario. (Note: You will not be graded on any changes you make to the graph.)
(Decrease or Increase)

Answer 1

Different variants of the above problem are available with students. The student is requested to make sure that the problem they are seeking a solution for is the same as the problem above. Saving is the source of supply of loanable fund and investment is the source of demand of loanable fund. Scenario 1: Suppose that the tax on deposits and bonds increases from 20% to 25%. This decreases the supply for loanable funds by shifting it to left. The following figure is showing its effect. Supply 1 Demand Supply INTEREST RATE (Percent) Demand LOANABLE FUNDS (Billions of dollars) As a result, interest rate rises and quantity for loanable fund falls. This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to rise and the level of investment spending to falls Scenario 2: Repealing the existing investment credit policy decreases the demand for loanable funds by shifting it to left. The following figure is showing its effect.

Demand Supply INTEREST RATE (Percent) As a result, interest rate falls and quantity for loanable fund falls. The repeal of existing of the tax credit causes the interest rate to fall and the level of savings to falls Scenario 3: Initially, the budget is balanced which means the government expenses are equal to government revenue. Now, suppose that government decreases its expenditure of national defence without the change in tax. This increases the public saving which causes the national saving increases. As a result, the supply of loanable funds increases by shifting to right. The following figure is showing its effect.

Supply 1 Supply INTEREST RATE (Percent) LOANABLE FUNDS (Bilions of dollars) As a result, interest rate falls and quantity for loanable fund rises. This change in spending causes the government to run a budget surplus, which increases national saving. This causes the interest rate to fall rise/increasing the level of investment spending.