When the government subsidizes investment, such as with an investment tax credit, the subsidy often applies to only some types of investment. This problem asks you to consider the effect of such a change. Suppose there are two types of investment in the economy: business investment and residential investment. And suppose that the government institutes an investment tax credit only for business investment.
a. How does the 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 new equilibrium. How does the policy affect the total quantity of investment? The quantity of business investment? The quantity of residential investment?