Question

Consider the market for loanable funds. If firms’ expectations about the economy improve and the government reduces taxes on investment income, the real interest rate will ______ and the quantity of loanable funds will _______

Either increase, decrease, or stay the same; increase
	Decrease; either increase, decrease, or stay the same
	Stay the same; stay the same
	Either increase, decrease, or stay the same; decrease
	Increase; either increase, decrease, or stay the same

Answer 1

Let's take the market for loanable funds.

If firms' expectations about the economy improve, it will lead to an increase in demand for loanable funds. This is because the firms would now want to create more capital which requires more borrowing. An increase in loanable funds demand will lead to a higher real interest in the market.

Let's see how a reduction in taxes on investment income by the government will impact the loanable funds market?

If the government reduces taxes on investments, it will lead to an increase in the supply of loanable funds because people have more income available to save. This will lead to a decrease in real interest rates.

Since the two factors have contradictory effects on the interest rates, the impact would be indeterminate. We don't know if interest rates will increase, decrease, or stay the same. On the other hand, the loanable funds will surely increase in the market.

Thus, These real interest rates will either increase, decrease, or stay the same and the loanable funds will increase.

The first option is the correct answer