Question

In: Economics

Scenario 1: Individual Retirement Accounts (IRAs) allow people to shelter some of their income from taxation....

Scenario 1: Individual Retirement Accounts (IRAs) allow people to shelter some of their income from taxation. Suppose the maximum annual contribution to such accounts is $5,000 per person. Now suppose there is a decrease in the maximum contribution, from $5,000 to $3,000 per year.

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 ____________ .

Scenario 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.

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 ________ .

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 _________ , 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.

Solutions

Expert Solution

Scenario 1

(a) Decrease in maximum IRA contribution will reduce savings, thus decreasing the supply of loanable funds, shifting the supply curve of loanable funds left.

(b) This change causes equilibrium interest rate to Increase and level of investment spending to Decrease.

Scenario 2

(a) Implementing investment tax credit program will increase business investment, shifting demand for loanable funds right.

(b) New investment tax credit causes interest rate to Increase and level of investment to Increase.

Scenario 3

(a) Increase in government defence spending increases the demand for loanable funds, shifting demand curve for loanable funds right.

(b) This causes government to run a Budget Deficit which Decreases national saving.

(b) This causes interest rate to Increase, Crowding out investment spending.

Rahul Sunny answered 1 year ago
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