1. Suppose there are only two types of private sector investments in Hing Hang I
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Question
1. Suppose there are only two types of private sector investments in Hing Hang Island's economy. Tourism investment and residential investment. The government imposed a 10% investment subsidy for new tourism investments only.
a) Explain how this policy affects the demand curve for tourism investment and also how it affects the demand curve for residential investment?
b) Draw the economy’s demand and supply for loanable funds. How does this policy affect the demand and supply for loanable funds? Explain what happens to the equilibrium interest rate?
c) Compare the old and the new equilibria. Discuss how does this policy affect the total quantity of investment? The quantity of tourism investment? The quantity of residential investment?
Explanation / Answer
Empowering the private sector to drive economic growth in low-income countries
A.10% Subsidy to attract foreign investment. Tourism has become an important sector that has an impact on development of country economy. The ability of the national economy to benefit from tourism depends on the availability of investment to develop the necessary infrastructure and on its ability to supply the needs of tourists.
Four sources of demand: households (personal consumption), other firms (investment), government agencies (government purchases), and foreign markets (net exports). Aggregate demand is the relationship between the total quantity of goods and services demanded (from all the four sources of demand) and the price level, all other determinants of spending unchanged. The aggregate demand curve is a graphical representation of aggregate demand.
The demand schedule most commonly consists of two columns. The first column lists a price for a product in ascending or descending order. The second column lists the quantity of the product that is desired, or demanded, at that price, which is determined based on research of the market. When the data in the demand schedule is graphed to create the demand curve, it provides a visual demonstration of the relationship between price and demand, allowing an easy estimation of the demand for a product or service at any point along the curve.
B.In economics, the loanable funds doctrine is a theory of the market interest rate. According to this approach, the interest rate is determined by the demand for and supply of loanable funds. The term loanable funds include all forms of credit, such as loans, bonds, or savings deposits.
Supply of Loanable Funds:
There are four important sources of the supply of loanable funds:
(1) Savings,
(2) Dishoarding,
(3) Bank money, and
(4) Disinvestment.
All of these sources are dependent upon the rate of interest, that is, they are interest-elastic.
Demand for Loanable Funds:
The demand for loanable funds comes from many sides. The Classical theory emphasised only the investment demand but loanable fund theorists consider other sources as well, that is, dissaving and hoarding.
(1) Investment Demand:
(2) Dissaving:
(3) Hoarding:
A change that begins in the loanable funds market can affect the quantity of capital firm’s demand. Here, a decrease in consumer saving causes a shift in the supply of loanable funds from S1 to S2 in Panel (a). Given the demand curve for capital, that interest rate then determines the quantity of capital firm’s demand.
C.The equilibrium rate of interest is determined by the interaction of the factors working on the demand and supply side of loanable funds. The rate of interest is determined where the demand curve DL intersects the supply curve SL. It is Oi. At any other rate, there would be disequilibrium in the loanable funds market and so it will have a tendency to come to the level Oi.
It can be easily seen here that at the equilibrium rate of interest Oi, investment is greater than saving. Since intended saving on the rate of interest Oi is greater than intended investment, it cannot be a stable rate of interest, for income will increase to shift the supply schedule of saving SL and hence of loanable funds to the right. This will change the rate of interest to curry it to the equilibrium level.
Let’s begin this discussion with a single economic event. It might be an event that affects demand, like a change in income, population, tastes, prices of substitutes or complements, or expectations about future prices. It might be an event that affects supply, like a change in natural conditions, input prices, or technology, or government policies that affect production. How does this economic event affect equilibrium price and quantity? We will analyze this question using a four-step process.
Step 1. Draw a demand and supply model before the economic change took place. To establish the model requires four standard pieces of information: The law of demand, which tells us the slope of the demand curve; the law of supply, which gives us the slope of the supply curve; the shift variables for demand; and the shift variables for supply. From this model, find the initial equilibrium values for price and quantity.
Step 2. Decide whether the economic change being analyzed affects demand or supply. In other words, does the event refer to something in the list of demand factors or supply factors?
Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram. In other words, does the event increase or decrease the amount consumers want to buy or producers want to sell?
Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.
Investment in the tourism industry means the creation of capital or goods capable of producing other goods or services in tourism industry for earning higher profits in the private sector or regional revitalization and economic growth for public purposes.
Residential investment is a form of real estate investment that constitutes one of the world most valuable assets due to its durability. ... Residential investment tends to be a small part of the stock of housing at any given point in time.
The quantity of investment demanded in any period is negatively related to the interest rate. This relationship is illustrated by the investment demand curve. A change in the interest rate causes a movement along the investment demand curve. A change in any other determinant of investment causes a shift of the curve.
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