Assume there is an increase in taxes by $5 million and no change in government spending. Answer the following and demonstrate your answers using a diagram. (Note: make sure you label everything in the graph correctly, and link it to your written explanations)
a. What effect will this have on the demand and supply of loanable funds? How will this affect the real interest rate and the quantity of investment?
b. Is the change in equilibrium investment the same, more, or less than the initial change in government spending? Why?
c. Now consider that, in addition to the original decrease in taxes there is an increase in government spending of $15 million. How would your answer in part a. change? Show it in a diagram.