Slide 1

ECON 111 Tutorial 3 Slide 2 Question 1 Explain briefly the difference between debt finance and equity finance and why they are important to promote growth in a modern economy. Debt finance is when a firm borrows money by selling bonds in the bond market or obtaining a loan from a financial intermediary like a bank. On the other hand equity finance is when a firm sells stock to savers in the financial market who will then own a share of that company in proportion to the equity bought. Both of these instruments are extremely important as the funds required for investment in an economy are raised in this manner and such investment brings about economic growth. Slide 3 Question 1 Savings are of vital importance to bring about investment and economic growth in an economy. Therefore making earnings on interest tax-free would serve as an incentive for more people to save. Use a loanable funds market diagram to illustrate the effect of such a measure, and its impact on the economy as a whole. Slide 4 Investment, which is vital for economic growth, has to come through savings in an economy. Therefore it is important to reward the savers and not penalise them (as high taxes on interest income may do) for performing this vital function. The ideal incentive would be to remove tax taken from interest earnings which would, as shown in the diagram, shift the supply curve to the right showing an increase in savings. Slide 5 Question 1 Explain clearly the effect of a government budget surplus on the loanable funds market and its impact on investment and economic growth of a country. You are expected to use a loanable funds market diagram to illustrate your arguments. Slide 6 Review 1 What is national saving? What is private saving? What is public saving? How are these variables related? National saving is the amount of a nation's income that is not spent on consumption or government purchases. Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. Public saving is the amount of tax revenue that the government has left after paying for its spending. The three variables are related because national saving equals private saving plus public saving. Slide 7 Question 1 When the government runs a budget surplus (T>G), savings by the government are positive, which increases the supply of loanable funds (shifts the supply curve in the loanable funds market to the right). Loanable funds Interest Rate Demand Supply 1 Supply 2 r1 r2 L1L2 I