Graph walkthrough · Macro · Loanable funds market

An investment tax credit

The government offers firms a tax credit on new machinery.

Step 1 of 3 · Before the credit

The horizontal axis is the quantity of loanable funds. The vertical axis is the real interest rate. The market is at E₀.

The chain in words

Step 1
Before the credit
The horizontal axis is the quantity of loanable funds. The vertical axis is the real interest rate. The market is at E₀.
Step 2
Demand for funds shifts right
The credit raises the after-tax return on new machines. At every interest rate, firms want to borrow more to buy them, so the demand for loanable funds shifts right. At the old rate, firms want more funds than savers offer.
Step 3
The real interest rate rises
The real interest rate rises. The higher return draws in more saving, a movement along supply. The market settles at E₁: a higher rate and more funds borrowed and invested.

Takeaway. Anything that raises the return on investment shifts the demand for loanable funds right, raising both the real interest rate and investment.

Draw it yourself

This shock: draw the graph The government runs a deficit Households save more Foreign savers lend here

More on the loanable funds market graph

A deficit crowds out investment A saving boom lowers rates Foreign capital flows in A budget surplus lowers rates

Go deeper

Lesson: Limits of Fiscal Policy

The walkthrough shows the chain. The lesson explains why each link holds, with worked examples and practice questions that remember what you get wrong.

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