Investment Tax Credit
The question
The government of Alta enacts an investment tax credit that lowers the cost to firms of purchasing new capital equipment. Assume household saving behavior is unchanged. Show the effect of the tax credit in the loanable funds market. Show the effect on the Loanable Funds Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Investment Tax Credit: the worked answer
On the Loanable Funds Market graph, Demand for loanable funds shifts right.
Why Demand for loanable funds shifts right
The investment tax credit raises the after-tax return on new capital, so more investment projects become profitable for firms at every real interest rate. Firms borrow in the loanable funds market to finance this investment, so the demand for loanable funds shifts to the right. Household saving decisions are unchanged by assumption, so the supply of funds stays put.
What happens to the equilibrium
The equilibrium real interest rate rises and the equilibrium quantity of loanable funds increases.
The mistake students make on this one
The classic wrong answer is to shift demand left, reasoning that if the credit makes each machine cheaper then firms need to borrow fewer dollars to buy the equipment they already planned on. A credit raises the after-tax return on capital, so projects that were not worth financing before now clear the hurdle; firms buy more equipment rather than buying the same equipment for less, and total borrowing rises.
On exam day
Memorize the three things that move the borrowing side of this graph: expected profitability, the productivity of new capital, and taxes that hit the return on capital. An investment tax credit is the second-most-tested of them after government borrowing, and it always moves demand right.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Demand for loanable funds shifts right and every other curve on the Loanable Funds Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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