4. Drop down choices for each blank :

a. saving / investment

b. increases / decreases

c. greater / less

d. surplus / shortage

e. raise / lower

f. increasing / decreasing

g. increasing / decreasing

4. Supply and demand for loanable funds The following graph shows the market for loanable funds in a closed economy. The upward-sloping orange line represents the supply of loanable funds, and the downwardsloping blue line represents the demand for loanable funds. Suppl / INTEREST RATE (Percent) (A) - _ _ _ _ _ _ _ _ .+ I I 2 I I D I mand 1 I I I o I I I I I o 100 200 300 400 500 600 LOANABLE FUNDS (Billions of dollars) v is the source of the supply of loanable funds. As the interest rate falls, the quantity of loanable funds supplied v . Suppose the interest late is 3.5%. Based on the previous graph, the quantity of loanable funds supplied is 7 than the quantity of loans demanded, resulting in a V of loanable funds. This would encourage lenders to V the interest rates they charge, thereby V the quantity of loanable funds supplied and V the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of % . 5. The market for loanable funds and government policy The following graph shows the market for loanable funds. For each of the given scenarios, adjust the appropriate curve on the graph to help you complete the questions that follow. Treat each scenario separately by resetting the graph to its original state before examining the effect of each individual scenario. (Note: You will not be graded on any changes you make to the graph.) Sup Iy Demand Supply ----------+ INTEREST RATE (Percent) D mand LOANABLE FUNDS (Billions of dollars) Scenario 1: 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 an increase in the tax rate on interest income, from 20% to 25%. Shift the appropriate curve on the graph to reect this change. This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to v and the level of investment spending to v . Scenario 2: An investment tax credit effectively lowers the tax bill of any rm that purchases new capital in the relevant time period. Suppose the government repeals a previously existing investment tax credit. Shift the appropriate curve on the graph to reect this change. The repeal of the previously existing tax credit causes the interest rate to v and the level of investment to v . Scenario 3: Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes. This change in spending causes the government to run a budget v , which V national saving. Shift the appropriate curve on the graph to reect this change. This causes the interest rate to V , v the level of investment spending