2007 B Macroeconomics FRQ#2
(A) Assume that businesses are granted a tax credit on spending for machinery. Using a CLG of the loanable funds market, show the effect of the business sector's response on the real interest rate.
OK, so if business are getting a tax credit (a tax credit means that they will get money from the government for buying machinery) for buying machinery. We can assume that more businesses will take out loans to buy machinery.
I think of loanable funds as money (funds) sitting in the banks and if businesses are going to the bank and taking out those funds then the supply of loanable funds must be decreasing.
It is also acceptable to think of this as government spending, if the government is giving money to businesses then we can think of it as government spending.
If you remember anything, when government spends the RIR increases.
Real interest rates is increasing.
(B) Now assume that the tax rate on interest income from household savings is lowered and there is no change in government budget deficits. Using a second loanable funds graph show the effects of the household's response on the real interest rates.
This means that the tax you pay, on interest you earn, from your savings account is lowered. So we can assume that more people will save. This implies that people will save more money in the banks and that the supply of loanable funds will increase.
If the supply of loanable funds increases then the RIR will fall.
Fiscal policy cheat sheet, Here.
(C) Given your answer to part (b) what will happen to the countries PPC in the Long-Run?
If people are saving more money, then the RIR is falling and more people will be taking out loans. Why? A lower interest rate means the cost of borrowing is lower and therefore more people borrow.
If more people borrow, we can assume that businesses are borrowing and that they are investing some of that money into Capital Goods. (Also called Capital Stock)
Capital Goods are goods like, factories, equipment, tools, shipping containers, cranes, etc and these are used to create other goods and in the long-run we expect society's ability to produce more goods to increase.
In essence the PPC will shift outward.
This post links, Growth, PPC, Productivity, Here.
** Productivity is linked with Capital Goods, as most people buying new machinery for their businesses are buying better machinery, this will make their workers more productive.**