Question 1

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

The ratio of debt to GDP tends to rise during wars, as government spending increases to fund the war effort. The ratio also rose during the decade that began in 2001, as a result of increased government spending on defense and homeland security, as well as the 2008 financial crisis. However, it fell during the late 1990s, when the government was running budget surpluses and the economy was growing.

Question 2

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 3

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When an investment tax credit is repealed, the incentive for firms to make investments decreases. This decreases the demand for loanable funds, ultimately leading to lower interest rates. At the same time, since there is less investment, the overall level of investment in the economy falls.

Question 4

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 has a smaller increase in debt in 2011 than in 2010, it suggests that the government is taking steps to reduce its deficit spending, which in turn could lead to lower interest rates. Lower interest rates would make borrowing cheaper and encourage greater investment, leading to increased economic activity.

Question 5

According to the loanable funds model, which of the following events would result in higher interest rates and greater saving?
A)Firms become pessimistic about the future and, as a result, they cut back on their plans to buy new equipment and build new factories.
B)The government goes from running a budget deficit to running a budget surplus.
C)Congress passes a reform of the tax laws that encourages greater saving.
D)Congress passes a reform of the tax laws that encourages greater investment.

Accepted Answer

The answer of According to the loanable funds model, which...

Question 6

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, the supply of loanable funds comes from private saving and government budget surpluses, while the demand for loanable funds comes from private investment and government budget deficits. Therefore, a government budget deficit affects the supply of loanable funds because it reduces the amount of funds available for private investment. Choice A correctly reflects this relationship in the loanable funds market.

Question 7

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 8

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 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

An increase in interest rates could be caused by a decrease in the money supply or an increase in demand for credit. An increase in investment could be caused by the government instituting an investment tax credit, which would provide an incentive for firms to invest more. Therefore, option B is correct as it explains how both interest rates and investment could increase at the same time. Option A and C do not explain this relationship. Option D is incorrect as there is a possible explanation.

Question 10

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 11

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 would suggest that the government is borrowing more money, which could increase the demand for credit and raise interest rates. At the same time, if there is a decrease in investment, it could indicate that businesses are less willing to borrow at higher interest rates or that consumers are reducing their spending, which could lead to a decrease in demand for goods and services and a decrease in investment. The other options (B and C) suggest policies that would encourage investment and savings, which would likely lead to a decrease in interest rates and an increase in investment.

Question 12

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 income rather than spending it all. The source of the demand for loanable funds is investment, as businesses and individuals borrow money to finance investments in new projects or expansions. Thus, choice A correctly identifies both the source of the supply and demand for loanable funds. Choices B, C, and D are incorrect as they do not correctly identify the source of the supply of loanable funds.

Question 13

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 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 ratio of debt to GDP in the United States has not always been less than one. It has exceeded one at certain points in history, such as during World War II when the debt-to-GDP ratio peaked at over 100%.

Question 15

Suppose the government changed the tax laws, with the result that people were encouraged to consume more and save less. Using the loanable funds model, a consequence would be
A)lower interest rates and lower investment.
B)lower interest rates and greater investment.
C)higher interest rates and lower investment.
D)higher interest rates and higher investment.

Accepted Answer

When people consume more and save less, the supply of loanable funds decreases, leading to higher interest rates and lower investment.

Question 16

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 the demand for loanable funds, causing interest rates to rise. This can lead to a decrease in private investment because businesses and individuals have to pay more to borrow money, making it less attractive to invest. Therefore, as a budget deficit increases government borrowing, it can lead to a decrease in private investment and a decline in overall investment levels.

Question 17

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

If the demand for loanable funds is more inelastic, it means that even if the interest rates change, the demand for funds will not change significantly. On the other hand, if the supply of loanable funds is more elastic, it means that there will be a significant increase in the quantity supplied in response to a change in interest rates. In this scenario, a change in tax laws that increases the supply of loanable funds will have a smaller effect on investment because the demand for loanable funds is relatively insensitive to interest rate changes.

Question 18

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 19

In the market for loanable funds, the interaction of the demand for, and supply of, loanable funds determines the equilibrium level of
A)the inflation rate.
B)gross domestic product.
C)the real interest rate.
D)the nominal interest rate.

Accepted Answer

The demand for loanable funds comes from borrowers who are willing to pay a certain interest rate for the use of funds. The supply of loanable funds comes from savers who are willing to lend their money for a certain interest rate. The interaction of these two determines the equilibrium real interest rate, which is the price at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded. This equilibrium real interest rate influences investment and borrowing decisions, which in turn affects economic growth and development.

Question 20

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

A budget deficit means the government is borrowing more, which increases the demand for credit and drives up interest rates. This makes it more expensive for businesses and consumers to borrow and invest, leading to a decrease in investment and crowding out.

Quiz 26: Saving, Investment, and the Financial System

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?

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

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

According to the loanable funds model, which of the following events would result in higher interest rates and greater saving?

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

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

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 events could explain an increase in interest rates together with an increase in investment?

When the government runs a budget deficit,

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

The source of the supply of loanable funds is

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,

Which of the following statements is not correct?

Suppose the government changed the tax laws, with the result that people were encouraged to consume more and save less. Using the loanable funds model, a consequence would be

Crowding out occurs when

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 events could explain a decrease in interest rates together with an increase in investment?

In the market for loanable funds, the interaction of the demand for, and supply of, loanable funds determines the equilibrium level of

Crowding out occurs when investment declines because