When the government subsidizes investement, such as with an investment tax credi
ID: 1185075 • Letter: W
Question
When the government subsidizes investement, such as with an investment tax credit, the subsidy often applies to only some types of investment. This question ask you to considerthe effects of such a change. Suppose there are two types of investment in the economy: business investment and residential investment. The interest rates adjust to equilibrate national savings and total investment, which is the sum of business investment and residential investment. Now suppose that the government institutes an investment tax credit only for business investment. a. how does this policy affect the demand curve for business investment? The demand curve for residential investment? b. Draw the economy's supply and demand for loanable funds. How does this policy affect the supply and demand for loanable funds? What happens to the equilibrium interest rate? c. Compare the old and the new equilibria. How does this policy affect the total quantity of investment? The quantity of business investment? The quantity of residential investment?Explanation / Answer
a. demand for business investment will increase. This would be an outward shift in the demand curve. To the extent that total investment is fixed, the demand curve for residential investment will shift inward. In reality, total investment isn't likely to be totally fixed, because government subsidies often occur at the state level and are designed to lure businesses from other states, which would increase total investment.
b. not sure about this one. Increased investment could increase the demand for loanable funds, but increased subsidy could decrease the demand for loanable funds (they wouldn't need loans for the amount of the subsidy). The interest rate would change in the opposite direction of demand.
c.The quantity of quantity of business investment would increase. The quantity of residential investment would decrease to the extent that the business investment would have otherwise gone into residential. However, the subsidy would likely attract new investment (money that otherwise wouldn't have been invested, money from businesses moving from out of state), so the quantity of total investment would increase.
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