Question

7. Suppose the government creates an investment incentive, such as a tax credit for undertaking capital improvements.

a. Show how the market for loanable funds is affected in a (well-labeled) graph

b. Explain how the equilibrium “price” and quantity have changed in this market

Answer 1

a) An government incentive to undertake capital improvement will increase the investment in the market because now investment are relatively easier than before, it will shift the investment demand curve to the right i.e. at a higher quantity and higher interest rate in the market. This is shown in the graph below.

A government initiative to increase the investment will shift the investment demand curve to the right. The new equilibrium will be at a higher interest rate and higher quantity. Savings $2 E1 $1 l" 10 15 Quantity

b) The change has increased the price i.e. the interest rate of the investment and also increased the quantity. Older interest rate was 1 and now its 2. New quantity is 15 previously it was 10.