Question 1

In 1995, MP Bill Gatt proposed that the income tax be replaced with a consumption tax. If his program had been passed, how would the equilibrium interest rate and the quantity of loanable funds have been affected?

Accepted Answer

Replacing income tax with a consumption tax encourages savings over consumption. This increase in savings would lead to an increase in the supply of loanable funds, which would lower the equilibrium interest rate and increase the equilibrium quantity of loanable funds.

Question 2

Generally, when economists talk of the "interest rate," what are they talking about?

Accepted Answer

The answer of Generally, when economists talk of the "interest...

Question 3

What would most likely happen in the market for loanable funds if the government were to increase the tax on interest income?

Accepted Answer

If the government were to increase the tax on interest income, it would reduce the return on savings and investments. This would lead to a decrease in the supply of loanable funds, as people would have less incentive to save and invest. As a result, interest rates would rise, as borrowers would need to offer higher rates to attract funds. Additionally, the decrease in savings would reduce the amount of available funds for investment purposes.

Question 4

If there is surplus of loanable funds, what is most likely to happen?

Accepted Answer

If there is a surplus of loanable funds, it means there is more supply than demand. As a result, lenders will lower the interest rate to entice borrowers and the quantity of loanable funds supplied will decrease, while the quantity demanded will increase. This occurs along the fixed supply and demand curves. Therefore, the correct answer is D.

Question 5

Suppose the Canadian government allowed taxpayers to earn their first $5000 interest free of income tax. How would this shift the supply of, or demand for, loanable funds?

Accepted Answer

Allowing taxpayers to earn their first $5000 interest free of income tax would increase their income after taxes. As a result, they would have more disposable income to save and invest, increasing the supply of loanable funds. This would shift the supply curve to the right.

Question 6

Suppose that the government were to replace the income tax with a consumption tax. What would happen to the interest rate and investment, respectively?

Accepted Answer

If the government replaces the income tax with a consumption tax, disposable income will increase for individuals, leading to an increase in consumption. This increase in consumption will, in turn, increase demand for goods and services, leading to an increase in investment. Therefore, investment will increase. However, this increase in demand will also lead to inflation, prompting the central bank to raise interest rates to control inflation. Thus, the interest rate will decrease, and investment will increase.

Question 7

If Parliament reduced the tax rate on interest income, what would most likely happen to investment and saving?

Accepted Answer

Reducing the tax rate on interest income makes saving more attractive because the after-tax return on savings would increase. This could lead to more saving. Additionally, as people save more, there is more capital available for investment, potentially lowering the cost of borrowing and encouraging more investment.

Question 8

-Refer to Table 8-4. Supposing the market for loanable funds is in equilibrium, what is the quantity of funds demanded?

Accepted Answer

The answer of 
-Refer to Table 8-4. Supposing the market...

Question 9

If the nominal interest rate is 10 percent and the rate of inflation is 2 percent, what is the real interest rate?

Accepted Answer

The real interest rate is calculated by subtracting the rate of inflation from the nominal interest rate. In this case, the real interest rate would be 8 percent (10 percent - 2 percent).

Question 10

What would most likely happen in the market for loanable funds if the government were to decrease the tax rate on interest income?

Accepted Answer

Decreasing the tax rate on interest income makes saving more attractive, increasing the supply of loanable funds as people are more willing to lend their money. However, it does not directly affect the demand for loans, which is primarily driven by borrowers' needs and the interest rate they face.

Question 11

What would most likely happen in the market for loanable funds if the government were to increase the tax on interest income?

Accepted Answer

An increase in the tax on interest income would reduce the return on lending, which would discourage lenders from supplying loanable funds. This would cause the supply of loanable funds to shift leftward.

Question 12

If the inflation rate is 2 percent and the real interest rate is 6 percent, what is the nominal interest rate?

Accepted Answer

Nominal interest rate = Real interest rate + Inflation rate
Nominal interest rate = 6% + 2% = 8%

Question 13

Which statement best defines the nominal interest rate?

Accepted Answer

The nominal interest rate is the interest rate as usually reported by banks or other financial institutions. It does not take into account inflation or other factors that may affect the real cost of borrowing or the real rate of return to the lender.

Question 14

Suppose a country has a consumption tax that is similar to a provincial sales tax. If its government eliminates the consumption tax and replaces it with an income tax that includes an income tax on interest from savings, what would most likely happen?

Accepted Answer

If a consumption tax is eliminated and replaced with an income tax on interest from savings, people would have less incentive to save their money. Lower saving means less funds available for investment, and with less money being invested, interest rates would increase. Therefore, the interest rate would increase and saving would decrease, making option C the correct choice.

Question 15

What would most likely happen in the market for loanable funds if the government were to decrease the tax on interest income?

Accepted Answer

When the government decreases the tax on interest income, individuals will have more incentive to save and invest. This will cause an increase in the supply of loanable funds (savings) and a decrease in the demand for loanable funds (as more individuals are able and willing to lend their money). As a result, the equilibrium interest rate will decrease, and both investment and savings will rise.

Question 16

If other things are the same, will countries that tax less on saving have lower or higher interest rates and investment than other countries?

Accepted Answer

Countries that tax less on saving typically encourage more saving among their population. This increased supply of savings in the financial markets tends to lower interest rates. Lower interest rates, in turn, make borrowing cheaper, which can lead to higher levels of investment.

Question 17

What would NOT result from replacing the income tax with a consumption tax?

Accepted Answer

Replacing the income tax with a consumption tax encourages savings and investment, as it shifts the tax burden from income to spending. This would likely increase investment rather than decrease it, as people would have more incentive to save and invest their money rather than spend it.

Question 18

If the nominal interest rate is 8 percent and the real interest rate is 2 percent, what is the inflation rate?

Accepted Answer

The formula for calculating the real interest rate is:

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Plugging in the given values, we have:

2% = 8% - Inflation Rate

Solving for the inflation rate, we get:

Inflation Rate = 8% - 2% = 6%

Therefore, the answer is B) 6 percent.

Question 19

-Refer to the Table 8-3. Supposing equilibrium exists in the market for loanable funds, what is the quantity of funds supplied in this market?

Accepted Answer

In equilibrium, the quantity of funds supplied equals the quantity of funds demanded. The table indicates that at equilibrium, the quantity of funds supplied is $2.5 trillion.

Question 20

If the nominal interest rate is 8 percent and the inflation rate is 4 percent, what is the real interest rate?

Accepted Answer

The real interest rate can be approximated by subtracting the inflation rate from the nominal interest rate: 8% - 4% = 4%.

Quiz 8: Saving, Investment, and the Financial System

In 1995, MP Bill Gatt proposed that the income tax be replaced with a consumption tax. If his program had been passed, how would the equilibrium interest rate and the quantity of loanable funds have been affected?

Generally, when economists talk of the "interest rate," what are they talking about?

What would most likely happen in the market for loanable funds if the government were to increase the tax on interest income?

If there is surplus of loanable funds, what is most likely to happen?

Suppose the Canadian government allowed taxpayers to earn their first $5000 interest free of income tax. How would this shift the supply of, or demand for, loanable funds?

Suppose that the government were to replace the income tax with a consumption tax. What would happen to the interest rate and investment, respectively?

If Parliament reduced the tax rate on interest income, what would most likely happen to investment and saving?

-Refer to Table 8-4. Supposing the market for loanable funds is in equilibrium, what is the quantity of funds demanded?

If the nominal interest rate is 10 percent and the rate of inflation is 2 percent, what is the real interest rate?

What would most likely happen in the market for loanable funds if the government were to decrease the tax rate on interest income?

What would most likely happen in the market for loanable funds if the government were to increase the tax on interest income?

If the inflation rate is 2 percent and the real interest rate is 6 percent, what is the nominal interest rate?

Which statement best defines the nominal interest rate?

Suppose a country has a consumption tax that is similar to a provincial sales tax. If its government eliminates the consumption tax and replaces it with an income tax that includes an income tax on interest from savings, what would most likely happen?

What would most likely happen in the market for loanable funds if the government were to decrease the tax on interest income?

If other things are the same, will countries that tax less on saving have lower or higher interest rates and investment than other countries?

What would NOT result from replacing the income tax with a consumption tax?

If the nominal interest rate is 8 percent and the real interest rate is 2 percent, what is the inflation rate?

-Refer to the Table 8-3. Supposing equilibrium exists in the market for loanable funds, what is the quantity of funds supplied in this market?

If the nominal interest rate is 8 percent and the inflation rate is 4 percent, what is the real interest rate?