Question

Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is a decrease in the tax rate on interest income, from 20% to 15%.

This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to (Fall/rise)______________ and the level of investment spending to (decrease/increase)_____ .
An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government implements a new investment tax credit.
Shift the appropriate curve on the graph to reflect this change.
The implementation of the new tax credit causes the interest rate to ____________(fall/rise)and the level of investment to(fall/rise)____ .
Initially, the government's budget is balanced, then the government responds to the conclusion of a war by significantly reducing defense spending without changing taxes.
This change in spending causes the government to run a budget___________(deficit/surplus) which____________(increases/decreases)national saving.
Shift the appropriate curve on the graph to reflect this change.
This causes the interest rate to ___(fall/rise)_______(increasing/crowding out)the level of investment spending.

Answer 1

The increase in the tax rate on interest income will cause the equilibrium interest rate to rise and level of investment spending to decrease.

The implementation of new tax credit result in the interest rate to rise and cause the level of investment to rise.

The reduction in the government spending made the government run a budget surplus, which increases national saving and causes the interest rate to fall, increasing the level of investment spending.

The increase in the tax rate on interest income has several significant economic implications:

• It discourages saving among individuals and businesses because they would retain less of their interest income after paying higher taxes. Consequently, the supply of loanable funds, which represents the pool of savings available for lending and investment, decreases.
• On a graphical representation of the loanable funds market, this reduction in supply is depicted as a leftward shift of the supply curve. As the supply of loanable funds diminishes, the equilibrium interest rate rises since lenders now require higher returns to compensate for the reduced availability of funds.

The implementation of an investment tax credit has a distinct impact on the loanable funds market.

• This policy effectively reduces the cost of borrowing for firms looking to invest in new capital assets. Consequently, firms are incentivized to increase their investment activities, as it becomes more financially appealing with the tax credit in place. This heightened demand for loanable funds is represented graphically by a rightward shift of the demand curve in the loanable funds market.
• As the demand for loanable funds increases, the equilibrium interest rate also rises, reflecting the higher demand for capital. Importantly, even though the interest rate increases, the level of investment spending rises as well because the tax credit makes investments more affordable, offsetting the impact of the higher interest rate.

Answer 2

1. Fall; Increase

As a result of a lower tax rate on interest income, more people will be encouraged to save because their earnings from savings will be more. This will increase the amount of loanable funds in the economy and when Supply is higher, prices drop. This is why interest will fall. The level of investment spending which is savings, will as earlier mentioned, increase.

2. Rise; Rise

As a result of the new tax credit on investment, companies will.want to invest more and buy more capital goods. This will lead them to acquire more loanable funds to finance the investments. This increases the demand for loanable funds thus shifting the demand curve for loanable funds to the right. As a result of this increase in demand, the interest rates will rise because more entities want loanable funds and according to Economics when demand rises, prices rise. The interest is the price in this scenario.

Investment evidently rises.

3. Surplus; Increases

The Government budget was balanced meaning that Expenditure equaled Revenue. The War ends and the Government reduces defense spending which means that Expenditure decreases yet Revenue remained the same. Revenue is now more than Expenditure meaning that the government has more money that it is spending which is a Surplus.

This will increases National Saving because the Government channels it into the Economy.

4. Fall; increasing

As a result of more savings in the economy, loanable funds increase which will shift the supply curve for loanable funds to the right. This will lead to a fall in interest rates. This fall in interest rates will encourage companies to take advantage of the lower rates and acquire more loans to invest which will increase Investment spending. I attached a graph to demonstrate.