Question

For each of the following scenarios, use supply and demand analysis to predict the resulting changes in the real interest rate, national saving, and investment. Show all your diagrams. (LO6) a. The legislature passes a 10 percent investment tax credit. Under this program, for every $100 that a firm spends on new capital equipment, it receives an extra $10 in tax refunds from the government b. A reduction in military spending moves the government's budget from deficit into surplus. c. A new generation of computer-controlled machines becomes available. These machines produce manufactured goods much more quickly and with fewer defects d. The government raises its tax on corporate profits. Other tax changes also are made, such that the government's deficit remains unchanged. e. Concerns about job security raise precautionary saving f. New environmental regulations increase firms' costs of operating capital.

Answer 1

Part A

Here the investment tax credit lowers the price of new capital goods to the firm by 10%. The investment and demand for saving also increased. So, the real interest rate, national saving and investment also raise.

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Part B

Here the increased public saving increases the national savings. So the supply curve shifted to the right. So, the real interest rate falls, and national saving and investment will rise.

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Part C

This is the case of the increased productivity of capital goods. That means the investment will be more profitable. So the demand for the saving curve shift to the right. So, the real interest rate, national saving and investment will rise.

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Part D

This is the case of increased corporate taxes, and it will reduce the after-tax return on capital investment. In this case, the firms are less willing to invest. And saving curve shift to the left. So, the real interest rate, national saving and investment will decline.

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Part E

Here the private saving increases the national income. So the supply of saving will shift to the right. The real interest rate falls, and national saving and investment will rise.

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Part F

The increased cost reduces the after-tax investment in the economy. Here, the firms are less likely to the willingness to invest and demand saving shift to the left. As a result, national saving, interest rate and investment will decline.

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