Final answer:
A reduction in the government's budget deficit, while keeping tax collections constant, will increase the supply of savings in the market for loanable funds, leading to potentially lower interest rates and stimulating investment.
Step-by-step explanation:
When the government reduces its budget deficit by decreasing government purchases G and holding net tax collections T constant, the effect in the market for loanable funds is an increase in the supply of savings. The national savings and investment identity illustrates this by showing public savings as (T - G). When G decreases and T stays the same, (T - G) becomes less negative or more positive, implying that the government is borrowing less to finance its shortfall. Consequently, there is less competition for loanable funds from the government, which increases the available supply of savings for other types of investment.A reduction in the budget deficit might not necessarily decrease the demand for investment, as private investment decisions are based on factors like expected returns and interest rates. It would not decrease the supply of savings; rather, it would increase it, making option (c) incorrect. Similarly, it wouldn't directly increase the demand for investment; thus, option (d) is also incorrect. This effect can be visualized through a shift to the right of the supply curve in the loanable funds market, leading to potential lower interest rates and making it more attractive for businesses to take out loans for investment purposes.In conclusion, a reduction in the government's budget deficit, with unchanged net tax collections, leads to an increase in the supply of loanable funds, represented by an increase in public savings within the national savings and investment identity.