1. Remember: the G taxes all income earned on interest and can influence the incentive to save by changing the tax on “interest income” (or dividends, or capital gains) • Ex: G decrease capital gains tax : • or G remove tax on dividends : • or G reduces tax on interest income: • 1. shift? • - because the incentive affects savings; we know that Savings = Supply • 2. direction? • – increase incentive to save = shift S right

2. 3. evaluate – • creates lower interest rate ( r ); move along D curve : and since a lower ( r ) makes it easier to borrow, and lead to greater investment (*remember I is part of GDP) = raise eq Q of Loanable Funds • Consider opposite examples

3. Taxes and Investment Ex: what if govt. gave incentive (decrease taxes) for firms to build new factories • 1. shift? • - because the incentive is to increase I, we know that I = Demand • 2. direction? • – incentive to increase I = shift D right

4. 3. evaluate • – creates higher ( r ) ; move along S curve: and since higher ( r ) makes it better to save = greater savings. = raise eq. Q of Loanable Funds • Consider opposite examples

5. Govt Budget Deficit (Deficit = more govt spending than taking in tax revenue) Govt. finance deficits by • borrowing in the bond market. (*accumulation of past govt. borrowing is called govt. debt. ) • 1. shift? • Govt. deficit is a reduction of national savings (private + public savings = national savings) • 2. direction? • - public savings is negative so shift S left

6. 3. evaluate- • creates higher ( r ) ; move along D curve: and since higher ( r ) makes it harder to borrow to invest, leads to reduced I …..sound familiar? • (= CROWDING OUT EFFECT) • Consider opposite examples

7. *when G tries expansionary fiscal policy by increasing G spending ; but they increase the deficit to do so; results in higher ( r ) which reduces I spending which reduces the expansionary effect. = Crowding Out Effect • *when G tries expansionary fiscal policy by increasing G spending ; but they increase the deficit to do so; results in higher ( r ) which makes dollar APPRECIATE, which reduces Nx , which reduces the expansionary effect…….= Nx Effect • Consider opposite examples

8. Note on bonds: • When a corporation or govt. issues a bond --- investor pays full price (ex. $1,000) • Earns FIXED INTEREST RATE (every 3 mos. or 6 mos.) (ex. 10%) • When the bond MATURES --- get full purchase price back • But – bonds can be bought and sold on NYSE before maturity. • Example: • Buy bond for $1,000 @ 10% , maturity = 10 yrs, interest paid every 6 mos. • In one year, you earned $200.

9. But --- you notice interest rates have increased (ex. 15%) so you figure you can get better returns on a different bond. You decide to sell it ,,,,,but who would buy a $1,000 bond w/ 10%, when they can get 15%. • To sell it, it is discounted [BOND PRICE DECREASES] ex- to $800….. • ….so as IR increase…….. • Bond prices decrease

10. Why would I buy this bond? • I buy bond for $800 , but …. • I am earning 10% on a $1000 bond • *****Inverse relationships between Interest Rates and Bond Prices