Suppose Parliament instituted an investment tax credit. Which of the following would most likely happen in the market for loanable funds?

Question

Quizplus · Accepted Answer

An investment tax credit is a government incentive to encourage investment. When Parliament institutes an investment tax credit, it would increase the after-tax return on investment, thereby stimulating investment demand. This increase in investment demand would lead to an increase in the demand for loanable funds; that is, firms would want to borrow more to finance the additional investments. This increase in demand for loanable funds would lead to an increase in the equilibrium interest rate. At the same time, the increase in investment demand would also shift the investment demand curve to the right, causing an increase in the equilibrium quantity of investment. Thus, both the interest rate and investment would rise in the market for loanable funds.

Suppose Parliament Instituted an Investment Tax Credit