What are the effects of an increase in government tax in the loanable fund market and on...

Question:

What are the effects of an increase in government tax in the loanable fund market and on aggregate demand and supply?

Loanable Funds

Loanable funds refer to the total amount of money which is saved by savers to lend to investors. The money which is saved by savers is the part of money income which was abstained from consumption. Loanable funds are provided by households to firms.

Answer and Explanation:

An increase in the government tax reduces the disposable income of people. When the disposable income of people falls, savings fall too. This leads to a reduction in supply of loanable funds. So, when taxes are increased the real interest rate associated with the loanable funds increases.

Since, there is a negative relationship between interest rates and investments, investments fall with the increase in real interest rate. A fall in investments lead to a fall in aggregate demand as investment is a part of aggregate demand. A fall in consumption level because of an increase in taxes reduces aggregate demand 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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