Question 1

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 net increase in government borrowing. This increased demand for loanable funds raises the equilibrium interest rate.

At the same time, as the interest rate rises, there is a decrease in the quantity of loanable funds demanded by businesses and households. As a result, the equilibrium quantity of loanable funds falls.

Question 2

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 increases the demand for loanable funds, causing an increase in the interest rate. This increase in interest rates reduces investment, as it makes borrowing more expensive for firms. Additionally, since the government is not saving any money, national saving is lower than it would be if the budget were balanced. Therefore, option C is the correct choice.

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 provide an incentive for businesses to invest. This increase in investment would create a higher demand for borrowing, pushing interest rates up.

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

If the government budget went from surplus to deficit, it may cause concerns about the government's ability to repay its debt, leading to an increase in interest rates. At the same time, a decrease in investment may result from the fact that the government is borrowing more, so there is less funds available for private investment. B and C wouldn't cause an increase in interest rates and a decrease in investment simultaneously, and D means none of the events is correct, which is not informative.

Question 5

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 interest rates fall, it becomes cheaper for businesses to borrow money to invest. However, if the government repeals an investment tax credit, businesses may be less inclined to invest despite the lower interest rates. Therefore, this could explain why investment falls despite the decrease in interest rates. A government going from a surplus to a deficit or replacing a consumption tax with an income tax may have other effects on the economy, but they do not directly explain the decrease in investment due to lower interest rates.

Question 6

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 increases, leading to higher interest rates that decrease investment by the private sector. This occurs because the government is competing with private borrowers for available funds, driving up the price of borrowing (i.e. interest rates). As a result, businesses and households may choose to postpone or cancel their investment plans, leading to a decline in overall investment.

Question 7

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 market, we define "loanable funds" as the flow of resources available to fund private investment. A government budget deficit affects the supply of loanable funds because it reduces the amount of savings available to be loaned out to private investors, leading to a decrease in the supply of loanable funds. It does not directly affect the demand for loanable funds.

Question 8

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, it means that the quantity demanded and supplied are relatively insensitive to changes in interest rates. Therefore, a change in the tax laws that increases the supply of loanable funds may not result in a significant change in interest rates, and consequently may have a smaller effect on investment.

Question 9

The ratio of debt to GDP in the United States
A) tends to rise during wars.
B) rose during the decade that began in 2001.
C) fell during the late 1990s.
D) All of the above are correct.

Accepted Answer

A) is correct, as the United States tends to borrow more during times of war. B) is correct, as the debt to GDP ratio increased significantly during the decade following 2001 due to the war on terror and the Great Recession. C) is correct, as the debt to GDP ratio fell during the late 1990s due to a strong economy and government efforts to reduce the deficit. Therefore, all of the statements are correct.

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

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 ratio of debt to GDP in the United States has not always been less than one. In fact, it has surpassed one multiple times throughout history.

Question 13

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 14

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 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 more money, leading to a higher demand for credit which then increases interest rates. This increase in interest rates reduces private investment, as businesses borrow less due to the higher cost of borrowing. A budget deficit leads to increased borrowing by the government, which in turn leads to crowding out of private investment. Thus, if a budget deficit makes interest rates rise, then option A is correct.

Question 16

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 17

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 typically leads to decreased demand for loans and thus a decrease in interest rates. With lower interest rates, investment becomes more attractive, leading to an increase in investment.

Question 18

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 individuals and businesses would have more funds available to save and lend. Similarly, if the budget deficit became smaller, it would indicate that the government is borrowing less, leaving more loanable funds available for private investment. Option B includes investment tax credits, which could increase demand for funds as businesses invest more, potentially mitigating the effects of any increase in supply. Option C includes a larger budget deficit, which would increase government borrowing and reduce the available supply of loanable funds. Option D includes tax reforms that discourage saving, which would reduce the available supply of loanable funds.

Question 19

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 indicates that the country's fiscal situation is improving. As a result, investors may see this as a positive signal and invest more. This increase in investment can lead to lower interest rates due to the higher demand for investments. Therefore, lower interest rates and greater investment in 2011 would be expected compared to 2010.

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 26: Saving, Investment, and the Financial System

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,

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?

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

Crowding out occurs when

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

The ratio of debt to GDP in the United States

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

Which of the following statements is not correct?

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

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

Crowding out occurs when investment declines because

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

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

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

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

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,