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 reflect 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 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 and the level of investment to . 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 , which national saving. Shift the appropriate curve on the graph to reflect this change. This causes the interest rate to , the level of investment spending.

1.This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to increase and the level of investment spending to decrease.

2. The implementation of the new tax credit causes the interest rate to   rise and the level of investment to rise.

3. This change in spending causes the government to run a budget deficit, which decrease national saving. This causes the interest rate to increase, crowding out the level of investment spending.

Explanation:

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%.

The effect of the increase in tax rate on interest income is a decrease savings that results in a reduction in the supply of loanable funds.

1-a. Shift the appropriate curve on the graph to reflect this change.

Note: See Graph A in the first panel of the attached picture to see how the appropriate curve on the graph is shifted to reflect the change.

From Graph A, it can be seen that as the tax rate on interest income increase, the supply curve of loanable funds shifts leftward from S1S1 to S2S2 but the demand curve of loanable funds still remains at DD without shifting. Eventually, the equilibrium interest rate in the market for loanable funds rises from r1 to r2 and the amount of loanable funds falls from F1 to F2.

1-b. This change in the tax treatment of interest income from saving causes the equilibrium interest rate in the market for loanable funds to increase and the level of investment spending to decrease.

The increase in the equilibrium interest rate in the market for loanable funds is the rise from r1 to r2 in Graph A and the decrease in the level of investment spending is the falls from F1 to F2.

2. 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.

When the government implement the new investment tax credit, it will increase business investment and then shift demand for loanable funds rightward.

2-a. Shift the appropriate curve on the graph to reflect this change.

Note: See Graph B in the second panel of the attached picture to see how the appropriate curve on the graph is shifted to reflect the change.

From Graph B, it can be observed that when the government implement the new investment tax credit, the demand curve of loanable funds shifts outward from D1D1 to D2D2 but the supply curve of loanable funds still remains at SS withou shifting. This makes the interest rate to rise from r1 to, while the amount of loanable funds also rises from F1 to F2.

2-b. The implementation of the new tax credit causes the interest rate to   increase and the level of investment to increase.

The increase in the interest rate is the rise from r1 to r2 in Graph B and the increase in the level of investment is the rise from F1 to F2.

3. Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes.

3-a. This change in spending causes the government to run a budget deficit, which decrease national saving.

3-b. Shift the appropriate curve on the graph to reflect this change.

Note: See Graph C in the third panel of the attached picture to see how the appropriate curve on the graph is shifted to reflect the change.

From Graph C, it can be observed that when the government increases budget spendings, it makes the demand curve of loanable funds shifts outward from D1D1 to D2D2 but the supply curve of loanable funds still remains at SS withou shifting. This leads to an increase in interest rate from r1 to r2, while the amount of loanable funds or govenment spending also rises from F1 to F2.

3-c. This causes the interest rate to increase, crowding out the level of investment spending.

The increase in the interest rate is the rise from r1 to r2 in Graph C and the increase in the level of government spending is the rise from F1 to F2.

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