Question

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.) Demand Supply Supply Demand LOANABLE FUNDS (Billons of dollars)

Answer 1

Scenario 1

(a) Decrease in maximum contribution to savings will decrease the supply of loanable funds, shifting the supply curve leftward as shown below.

Demand Supply Supply emand LOANABLE FUNDS (Billions of dollars)

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

Scenario 2

(a) New investment tax credit will increase investment demand, shifting demand for loanable funds to right as shown below.

Demand Supply Supply Demand LOANABLE FUNDS (Billions of dollars)

(b) This repeal causes interest rate to Rise and level of investment to Rise.

Scenario 3

(a) Increased government spending increases investment demand, shifting demand for loanable funds to right as shown below.

Demand Supply Supply Demand LOANABLE FUNDS (Billions of dollars)

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

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