Question

1. Using a supply and demand diagram, show the effect of the following policies on the...

1. Using a supply and demand diagram, show the effect of the following policies on the real interest rate and the amount of investment in the economy. show work.

a) the introduction of an investment tax credit

b) Government spending falls

c)Taxes increase

d) New policies make it more attractive for households to save

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Answer #1

a) Demand for investment will shift out.
hence, interest rate and investment level will rise.


b) Fall in government spending will increase national saving. Supply curve will shift out. Interest rate will fall and investment level will rise.


c) Increase in tax rate has dual effect. First, it increases public saving. Secondly, it reduces private saving.
Assume, increase in public saving is lower than reduction in private saving. Then, supply curve will shift in. Interest rate will rise and investment will fall.


d) Supply will shift out. Interest rate will fall and investment will rise.

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