04.07THE LOANABLE FUNDS MARKET

For each prompt below, carefully and thoroughly follow the directions. For the graphs, be certain to accurately label all axes, curves, and equilibria points. Use arrows to indicate the direction of any shifts.

A country is operating at full employment when its government lowers the tax rate on earnings from interest for household saving.

(a) Draw a fully labeled market for loanable funds, illustrating the impact of the tax rate change.

(b) Based on the change in part (a), will the demand for loanable funds in this economy increase, decrease, or remain the same? Explain.

(c) How will the change from part (a) affect business investment?

(d) How would these changes affect the country's rate of economic growth? Explain.

(e) Assume the government decreased deficit spending at the same time that it lowered the tax rate. Indicate the likely short-run impact on each of the following (increase, decrease, remain constant, or indeterminate):

i. equilibrium real interest rate

ii. equilibrium quantity of loanable funds

For each of the following scenarios, illustrate the impact on a fully labeled loanable funds graph.

(f) People in the economy increase their tendency to make big purchases through credit.

(g) The Federal Reserve raises the discount rate.

(h) There is a significant decrease in consumer and business confidence.