Question

using the market for loanable Funds and the market for Foreign Currency exchange, How does an investment tax credit affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rat, and balance? the trade

Answer 1

An investment tax credit increases firm investment, which increases the demand for loanable funds. Demand curve for loanable funds shifts rightward, increasing both interest rate and quantity of loanable funds.

Increase in interest rate decreases net capital outflow, in turn decreasing net exports. As net exports is an inverse function of exchange rate, lower net exports will increase exchange rate.

In following graph, panel A depicts loanable funds demand curve and supply curve. D0 and S0 are initial demand and supply curves intersecting at point A with initial real interest rate r0 and initial quantity of loanable funds Q0.

Panel B depicts net capital outflow as an inverse function of interest rate. Panel C depicts net exports (NX) as an inverse function of exchange rate.

After investment tax credit, D0 shifts right to D1, intersecting S0 at point B with higher interest rate r1 and higher quantity of loanable funds (national savings and investment) Q1. In panel B, higher interest rate from r0 to r1 decreases net capital outflow from NCO0 to NC01. In panel C, decrease in NCO decreases net exports from NX0 to NX1, increasing exchange rate from e0 to e1.

X De ca ) So B (b) yo D1 NCO() DO so 31 8 NCO NCO NCO е. lo NXC) NX NXO NY