Question

This chapter explains that investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit.

a. Why is it difficult to implement both of these policies at the same time?

(b) With reference to problem above, study the effect of each of the below mentioned policies on the market of loanable funds and economic growth of the country.

(1) Reducing taxes on private saving

(2) Reducing the government budget deficit.

Draw graphs of the market of Loanable funds to elaborate your answer and explanation.

Answer 1

a) Investments can be increased either by reducing the taxes on private saving and reducing the government budget deficit but it is difficult to implement both of these policies at the same time because if reduce the taxes on private saving may result in increase in budget deficit unless some other taxes are reduced .Hence both the policies cannot be operated at the same time.

(b) 1. If the taxes on private savings are reduced it may lead to more disposable income .Disposable income refers to the income of individuals after the deduction of tax .This will lead to reduced interest rate and hence there is an increase in supply of loanable funds in the market of loanable funds.This is because with the increased disposable income individuals have more income to save.Hence when there is an increase in saving it will cause an rightward shift in the supply curve as shown in the figure.

2.when there is an decrease in the government budget deficit it will cause the supply curve of the loanable funds to shift to the right.When there is decrease in the deficit there is a rightward shift in the supply curve and if the deficit increases there is an increase in the demand of loanable funds.

Hence in both the cases that is when there is reduction of taxes on private saving and reducing the government budget deficit it will cause the supply curve to shift to the right as shown in the figure and the rate of interest will decrease

a) Investments can be increased either by reducing the taxes on private saving and reducing the government budget deficit but it is difficult to implement both of these policies at the same time because if reduce the taxes on private saving may result in increase in budget deficit unless some other taxes are reduced .Hence both the policies cannot be operated at the same time.

(b) 1. If the taxes on private savings are reduced it may lead to more disposable income .Disposable income refers to the income of individuals after the deduction of tax .This will lead to reduced interest rate and hence there is an increase in supply of loanable funds in the market of loanable funds.This is because with the increased disposable income individuals have more income to save.Hence when there is an increase in saving it will cause an rightward shift in the supply curve as shown in the figure.

2.when there is an decrease in the government budget deficit it will cause the supply curve of the loanable funds to shift to the right.When there is decrease in the deficit there is a rightward shift in the supply curve and if the deficit increases there is an increase in the demand of loanable funds.

Hence in both the cases that is when there is reduction of taxes on private saving and reducing the government budget deficit it will cause the supply curve to shift to the right as shown in the figure and the rate of interest will decrease