Question 1

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

If the government budget went from surplus to deficit, there may be an increase in demand for credit, which could cause interest rates to rise. However, the decrease in investment could be due to the fact that the government is competing with private investors for loans, causing interest rates to rise and making it more expensive for firms to invest. Alternatively, the government may be reducing its own investment spending in order to balance the budget, leading to a decrease in investment overall. Choices B and C both suggest policies that could increase investment, making them unlikely explanations for a decrease in investment.

Question 2

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

The answer of Suppose government expenditures on goods and services...

Question 3

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...

Question 4

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 by increasing the amount of funds available for lending. Similarly, a smaller budget deficit would also increase the supply of loanable funds as the government would be borrowing less and thus making more funds available for private lending. Option B is also partially correct, as investment tax credits could also encourage more saving and thus increase the supply of loanable funds, but the second part of the option (increasing investment tax credits) would actually increase demand for loanable funds, not supply, as firms would be borrowing more to invest in projects. Option C and D are incorrect as they would both decrease the supply of loanable funds, with a larger budget deficit indicating that the government is borrowing more and thus reducing funds available for private lending, and tax reforms that discourage saving reducing the amount of funds available for lending.

Question 5

Suppose the government deficit increases, but the interest rate remains the same. Which of the following things might have happened simultaneously to keep interest rates the same?
A) The government reduces the amount that people may put into savings accounts on which the interest is tax exempt.
B) Because they are optimistic about the future of the economy, firms desire to borrow more to purchase physical capital.
C) Consumers decide to decrease consumption and work more.
D) All of the above could explain why the interest rate would be unchanged.

Accepted Answer

The answer of Suppose the government deficit increases, but the...

Question 6

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

An increase in government expenditures on goods and services will shift the demand for loanable funds to the right, causing the interest rate to rise. An increase in taxes will decrease disposable income and consumption, leading to a decrease in investment demand and a leftward shift in the supply of loanable funds, causing the interest rate to rise even further. The combination of these two effects will result in a higher equilibrium interest rate and a lower equilibrium quantity of loanable funds.

Question 7

A decrease in the budget deficit
A) makes investment spending fall.
B) makes investment spending rise.
C) does not affect investment spending.
D) may increase, decrease, or not affect investment spending if private saving doesn't change.

Accepted Answer

When the budget deficit decreases, it means that the government is spending less than it is collecting in revenue. This decrease in government borrowing reduces the competition with private borrowers for available funds, and interest rates will likely decrease as a result. Lower interest rates make it cheaper for businesses to borrow money for investment, leading to an increase in investment spending.

Question 8

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

When the government runs a budget deficit, it borrows money by issuing bonds. This increases the demand for loanable funds, which results in higher interest rates, making investment more expensive. As a result, investment is lower than it would be if the budget were balanced. Option A is incorrect because interest rates are usually higher when the government runs a deficit. Option B is incorrect because a budget deficit implies that the government is spending more than it is receiving in revenue, so national saving is actually lower than it would be if the budget were balanced.

Question 9

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

If the government institutes an investment tax credit, it will encourage investment, which will lead to an increase in investment. However, this increased demand for investment will also increase the demand for loanable funds, driving up interest rates.

Question 10

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 11

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 12

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 13

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

When a country has a smaller increase in debt, it generally signals greater fiscal responsibility and financial stability. This can lead to lower interest rates as lenders are more confident in the country's ability to repay its debts. Lower interest rates can then encourage greater investment as borrowing becomes cheaper for both individuals and businesses. Therefore, we would expect lower interest rates and greater investment in 2011 than in 2010.

Question 14

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 15

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

Crowding out occurs when the government borrows funds to finance its expenditures, which increases the demand for credit and subsequently raises interest rates, thus making borrowing more expensive for private firms and individuals. This decrease in private investment is referred to as the crowding-out effect. Therefore, a budget deficit (when the government spends more than it receives in revenue) makes interest rates rise, leading to the crowding-out effect.

Question 16

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

When the budget deficit of a country reduces, it indicates that the country is spending less than its revenue. This reduces the government's borrowing needs, causing a decrease in demand for loans, which lowers interest rates. Lower interest rates will, in turn, increase investment as borrowing money becomes cheaper for businesses, making it more accessible to fund expansions and new projects. Therefore, the reduction in the budget deficit in Bolivia in 2003 is expected to decrease interest rates and increase investment.

Question 17

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, loanable funds refer to the resources available for private investment. A government budget deficit affects the supply of loanable funds by increasing government borrowing, thereby reducing the amount of funds available for private investment. This reduces the supply of loanable funds, leading to an increase in interest rates, which in turn affects borrowing and investment decisions. Government budget deficits do not directly affect the demand for loanable funds.

Question 18

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 and the supply of loanable funds is more elastic, a change in the tax laws that increases the supply of loanable funds will have a smaller effect on investment. This is because a relatively small change in interest rates will have a small effect on the quantity of loanable funds demanded by investors, while a relatively large change in interest rates will result in a larger increase in the quantity of loanable funds supplied. Therefore, the increase in investment will be less significant.

Question 19

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

Accepted Answer

Crowding out occurs when government borrowing to finance a budget deficit increases the demand for loanable funds, causing interest rates to rise. This makes borrowing more expensive for private investors, leading to a decline in their investment. Therefore, option A is the correct choice.

Question 20

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 decreases the incentive for individuals and companies to invest. This decrease in investment can lead to a decrease in demand for loans, causing interest rates to fall.

Quiz 18: Saving, Investment, and the Financial System

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

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

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,

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

Suppose the government deficit increases, but the interest rate remains the same. Which of the following things might have happened simultaneously to keep interest rates the same?

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 decrease in the budget deficit

When the government runs a budget deficit,

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

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?

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

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

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

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

Crowding out occurs when investment declines because

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 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

Crowding out occurs when

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