Use the loanable funds model to explain what would happen to private savings, private investment...

Question:

Use the loanable funds model to explain what would happen to private savings, private investment spending and the rate of interest if the following events occur. Assume the government has a balanced budget prior to occurrence of each event. Use a separate graph for each event.

a. Government increases the income tax rate on the interest earned on savings accounts.

b. Government announces that Social Security benefits will be reduced by 50% for aII people born after 1990.

c. Government increases its spending on education by $20 billion and does not increase taxes to pay for the increase in spending.

Loanable funds market:

It is a market structure where there are borrwoers of funds and lenders of funds. The households are the lenders where they lend out their savings to earn profit in the form of interest rates and the government and private investors are the borrowers.

Answer and Explanation:

a. As tax rate increases on the interest rate on the savings, then lenders would be less willing to lend out money in the market. The supply curve will shift to the left, the rate of interest will be higher and the quantity of money in the market will be lower.

Supply curve shifts to the left, interest aret increases and the quantity of money will decrease.

b. With reduced social security benefits the households would require more money in hand and hence supply less money in the market to lend out. The supply curve will shift to the left, the interest rates would increase and the quantity of money will decrease.

Supply curve shifts to the left, interest aret increases and the quantity of money will decrease.

c. When the government launches such a scheme with no increase in taxes, so the government would fund this scheme by borrowing from the loanble market. The demand curve will shift to the right. The interest rates and the quantity of money will increase.

Demand curve shifts to the right, interest rate increases and the quantity of money will increase too.


Learn more about this topic:

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Loanable Funds: Definition & Theory

from Introduction to Business: Homework Help Resource

Chapter 25 / Lesson 29
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