Question 1

Suppose a country had a smaller increase in debt in 2011 than it had in 2010. Then other things the same, we would expect
A)lower interest rates and investment in 2011 than in 2010.
B)lower interest rates and greater investment in 2011 than in 2010.
C)higher interest rates and greater investment in 2011 than in 2010.
D)higher interest rates and lower investment in 2011 than in 2010.

Accepted Answer

If a country had a smaller increase in debt in 2011 than it had in 2010, it implies that the country has made efforts to reduce its budget deficit, which would signal to investors that the country is taking steps to improve its fiscal health. This would lead to an increase in investor confidence, resulting in lower interest rates and greater investment in the country.

Question 2

The source of the supply of loanable funds is
A)saving, and the source of the demand for loanable funds is investment.
B)consumption, and the source of the demand for loanable funds is investment.
C)investment, and the source of the demand for loanable funds is saving.
D)the interest rate, and the source of the demand for loanable funds is saving.

Accepted Answer

The source of the supply of loanable funds is saving, as individuals and businesses save their money in banks or other financial institutions, which in turn lend out those funds to borrowers. The source of the demand for loanable funds is investment, as businesses borrow money to finance their investments in capital goods, research and development, and other activities aimed at increasing their production and profits. Therefore, choice A correctly identifies the source of the supply and demand for loanable funds, while the other choices do not.

Question 3

Which of the following events could explain an increase in interest rates together with an increase in investment?
A)The government runs a larger deficit.
B)The government institutes an investment tax credit.
C)The government replaces the income tax with a consumption tax.
D)None of the above is correct.

Accepted Answer

The government instituting an investment tax credit would incentivize firms to invest more, leading to an increase in investment. However, this increase in investment may lead to an increase in demand for credit, which could lead to an increase in interest rates. Option A is incorrect because a larger deficit would likely lead to an increase in interest rates due to the government's increased borrowing needs, but it would not necessarily lead to an increase in investment. Option C is incorrect because a shift from income tax to consumption tax would not directly impact interest rates or investment.

Question 4

Which of the following events could explain an increase in interest rates together with a decrease in investment?
A)The government budget went from surplus to deficit.
B)The government instituted an investment tax credit.
C)The government reduced the tax rate on savings.
D)None of the above is correct.

Accepted Answer

When the government budget goes from surplus to deficit, it means the government is borrowing more money. This can lead to an increase in interest rates to attract investors to purchase the government's debt. However, the increase in interest rates can also lead to a decrease in investment as it becomes more expensive for businesses to borrow money for investments.

Question 5

Other things the same, if the government increases transfer payments to households, then the effect of this on the government's budget
A)will make investment rise.
B)will make the rate of interest rise.
C)will make public saving rise.
D)All of the above are correct.

Accepted Answer

The answer of Other things the same, if the government...

Question 6

Which of the following events could explain a decrease in interest rates together with an increase in investment?
A)The government went from surplus to deficit.
B)The government instituted an investment tax credit.
C)The government reduced the tax rate on savings.
D)None of the above is correct.

Accepted Answer

The answer of Which of the following events could explain...

Question 7

Bolivia had a smaller budget deficit in 2003 than in 2002. Other things the same, we would expect this reduction in the budget deficit to have
A)increased both interest rates and investment.
B)increased interest rates and decreased investment.
C)decreased interest rates and increased investment.
D)decreased both interest rates and investment.

Accepted Answer

A reduction in the budget deficit signals a decrease in borrowing needs by the government, which in turn decreases demand for loanable funds. This decrease in demand for loanable funds reduces interest rates, making it cheaper for firms to invest, which should increase investment.

Question 8

Suppose government expenditures on goods and services and net taxes both decrease, and expenditures fall by more than net taxes. The effects of these changes on the budget deficit cause
A)both the equilibrium interest rate and the equilibrium quantity of loanable funds to fall.
B)both the equilibrium interest rate and the equilibrium quantity of loanable funds to rise.
C)the equilibrium interest rate to rise and the equilibrium quantity of loanable funds to fall.
D)the equilibrium interest rate to fall and the equilibrium quantity of loanable funds to rise.

Accepted Answer

When government expenditures on goods and services and net taxes both decrease, and expenditures fall by more than net taxes, this will decrease the budget deficit. As a result, the demand for loanable funds will decrease, causing the equilibrium interest rate to fall. At the same time, the decrease in government expenditures will increase private investment and consumption, leading to an increase in the supply of loanable funds, causing the equilibrium quantity of loanable funds to rise. Therefore, the correct answer is D.

Question 9

The supply of loanable funds would shift to the right if either
A)tax reforms encouraged greater saving or the budget deficit became smaller.
B)tax reforms encouraged greater saving or investment tax credits were increased.
C)the budget deficit became larger or investment tax credits were increased.
D)the budget deficit became larger or tax reforms discouraged saving.

Accepted Answer

Tax reforms that encourage greater saving would increase the supply of loanable funds, as savers would be willing to lend more money. Similarly, if the budget deficit became smaller, there would be less need for the government to borrow, freeing up loanable funds. Increasing investment tax credits, as in choice B, would stimulate investment and increase the demand for loanable funds, not the supply. The scenarios in choice C and D would reduce the supply of loanable funds: a larger budget deficit would increase the government's demand for borrowing, and tax reforms that discourage saving would reduce the willingness of savers to lend.

Question 10

Crowding out occurs when investment declines because
A)a budget deficit makes interest rates rise.
B)a budget deficit makes interest rates fall.
C)a budget surplus makes interest rates rise.
D)a budget surplus makes interest rates fall.

Accepted Answer

When there is a budget deficit, the government may need to borrow to finance its spending. This increases the demand for credit in the market, causing interest rates to rise. This rise in interest rates can discourage private investment in projects that require borrowing, thereby crowding out private investment.

Question 11

The ratio of debt to GDP in the United States
A)tends to fall during wars.
B)fell during the decade that began in 2000.
C)fell during the late 1990s.
D)None of the above is correct.

Accepted Answer

The ratio of debt to GDP in the United States fell during the late 1990s due to a combination of strong economic growth and budget surpluses. However, it has been increasing since the early 2000s and is currently at a historically high level. Option A is incorrect because wars typically increase government spending and debt, leading to a higher debt-to-GDP ratio. Option B is incorrect because the debt-to-GDP ratio increased during the decade that began in 2000. Therefore, the correct answer is option C.

Question 12

A government budget deficit affects the supply of loanable funds, rather than the demand for loanable funds, because
A)in our model of the loanable funds market, we define "loanable funds" as the flow of resources available to fund private investment.
B)in our model of the loanable funds market, we define "loanable funds" as the flow of resources available from private saving.
C)markets for government debt are fundamentally different from markets for private debt.
D)of our assumption that the economy is closed.

Accepted Answer

In the loanable funds model, we define "loanable funds" as the flow of resources available to fund private investment. The government deficit affects the supply of loanable funds because it reduces the amount of funds available for private investment, as the government is borrowing funds from the same pool of savings that would otherwise be available for private investment. Therefore, the demand for loanable funds is not directly affected by the government deficit, but rather the supply of loanable funds.

Question 13

A change in the tax laws that increases the supply of loanable funds will have a smaller effect on investment when
A)the demand for loanable funds is more elastic and the supply of loanable funds is more inelastic.
B)the demand for loanable funds is more inelastic and the supply of loanable funds is more elastic.
C)both the demand for and supply of loanable funds are more elastic.
D)both the demand for and supply of loanable funds are more inelastic.

Accepted Answer

When the demand for loanable funds is more inelastic, it means that a change in interest rates will not change the demand for loanable funds significantly. Similarly, when the supply of loanable funds is more elastic, it means that a change in interest rates will result in a large increase in the supply of loanable funds. Therefore, when a change in tax laws increases the supply of loanable funds, there will be a smaller effect on investment if the demand for loanable funds is more inelastic and the supply of loanable funds is more elastic (option B).

Question 14

Which of the following statements is not correct?
A)If GDP is rising faster than debt, the government is, in some sense, living within its means.
B)The ratio of debt to GDP in the United States has always been less than one.
C)Debts during wars may distribute the burden of fighting the war more evenly across generations.
D)During times of peace in the United States, the ratio of debt to GDP sometimes rose.

Accepted Answer

The statement is false. The ratio of debt to GDP in the United States has exceeded one multiple times throughout history.

Question 15

Suppose government expenditures on goods and services increase, transfers are unchanged, and taxes rise by less than the increase in expenditures. These changes in the government's budget cause
A)both the equilibrium interest rate and the equilibrium quantity of loanable funds to fall.
B)both the equilibrium interest rate and the equilibrium quantity of loanable funds to rise.
C)the equilibrium interest rate to rise and the equilibrium quantity of loanable funds to fall.
D)the equilibrium interest rate to fall and the equilibrium quantity of loanable funds to rise.

Accepted Answer

When government expenditures on goods and services increase, transfers are unchanged, and taxes rise by less than the increase in expenditures, there is a budget deficit. This budget deficit increases the demand for funds, leading to an increase in the equilibrium interest rate. At the same time, the increase in government expenditures reduces the supply of funds, leading to a decrease in the equilibrium quantity of loanable funds. Hence, the correct option is C- the equilibrium interest rate to rise and the equilibrium quantity of loanable funds to fall.

Question 16

When the government runs a budget deficit,
A)interest rates are lower than they would be if the budget were balanced.
B)national saving is higher than it would be if the budget were balanced.
C)investment is lower than it would be if the budget were balanced.
D)All of the above are correct.

Accepted Answer

The answer of When the government runs a budget deficit,
A)interest...

Question 17

Suppose the Congress and president decreased the maximum annual contributions limits to retirement accounts and at the same time reduced the budget deficit. What would happen to the interest rate?
A)It would decrease.
B)It would increase.
C)It would stay the same.
D)It might do any of the above.

Accepted Answer

The answer of Suppose the Congress and president decreased the...

Question 18

Interest rates fall and investment falls. Which of the following could explain these changes?
A)The government goes from a surplus to a deficit.
B)The government repeals an investment tax credit.
C)The government replaces a consumption tax with an income tax.
D)None of the above is correct.

Accepted Answer

When the government repeals an investment tax credit, it becomes more expensive for firms to invest and thus they invest less. This decrease in investment would cause interest rates to fall.

Question 19

If we were to change the interpretation of the term "loanable funds" in such a way that government budget deficits would affect the demand for loanable funds, rather than the supply of loanable funds, then
A)crowding out would not be a consequence of an increase in the budget deficit.
B)higher interest rates would not be a consequence of an increase in the budget deficit.
C)an increase in the budget deficit would cause the demand for loanable funds to decrease.
D)we would be making only a semantic change in how we analyze the effects of government budget deficits.

Accepted Answer

Changing the interpretation of how government budget deficits affect the loanable funds market (from affecting supply to affecting demand) does not alter the underlying economic mechanisms or outcomes; it merely changes the terminology used to describe these processes.

Question 20

Suppose the government ran a budget surplus in 2010 and a larger surplus in 2011. The loanable funds model would predict that, as a result of the increase in the surplus,
A)both the government debt and interest rates increased between 2010 and 2011.
B)both the government debt and interest rates decreased between 2010 and 2011.
C)the government debt increased and interest rates decreased between 2010 and 2011.
D)the government debt decreased and interest rates increased between 2010 and 2011.

Accepted Answer

The answer of Suppose the government ran a budget surplus...

Quiz 13: Saving, Investment, and the Financial System

Suppose a country had a smaller increase in debt in 2011 than it had in 2010. Then other things the same, we would expect

The source of the supply of loanable funds is

Which of the following events could explain an increase in interest rates together with an increase in investment?

Which of the following events could explain an increase in interest rates together with a decrease in investment?

Other things the same, if the government increases transfer payments to households, then the effect of this on the government's budget

Which of the following events could explain a decrease in interest rates together with an increase in investment?

Bolivia had a smaller budget deficit in 2003 than in 2002. Other things the same, we would expect this reduction in the budget deficit to have

Suppose government expenditures on goods and services and net taxes both decrease, and expenditures fall by more than net taxes. The effects of these changes on the budget deficit cause

The supply of loanable funds would shift to the right if either

Crowding out occurs when investment declines because

The ratio of debt to GDP in the United States

A government budget deficit affects the supply of loanable funds, rather than the demand for loanable funds, because

A change in the tax laws that increases the supply of loanable funds will have a smaller effect on investment when

Which of the following statements is not correct?

Suppose government expenditures on goods and services increase, transfers are unchanged, and taxes rise by less than the increase in expenditures. These changes in the government's budget cause

When the government runs a budget deficit,

Suppose the Congress and president decreased the maximum annual contributions limits to retirement accounts and at the same time reduced the budget deficit. What would happen to the interest rate?

Interest rates fall and investment falls. Which of the following could explain these changes?

If we were to change the interpretation of the term "loanable funds" in such a way that government budget deficits would affect the demand for loanable funds, rather than the supply of loanable funds, then

Suppose the government ran a budget surplus in 2010 and a larger surplus in 2011. The loanable funds model would predict that, as a result of the increase in the surplus,