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IAI Actuarial Core Principles · Business Economics · Consumer demand and behaviour

In a market for home loans the equilibrium interest rate is initially 9%. The government introduces a tax rebate on interest paid, which raises borrowers' demand at every rate, while supply of loanable funds is unchanged and upward sloping. What happens in the new equilibrium?

Both the interest rate and the quantity of loans rise. The rebate shifts demand right, creating excess demand at 9%, and lenders respond along an upward-sloping supply curve to a higher rate and larger quantity.

  1. AInterest rate rises and quantity of loans risesCorrect
  2. BInterest rate falls and quantity of loans rises
  3. CInterest rate rises and quantity of loans falls
  4. DInterest rate and quantity both remain unchanged
  5. Interest rate falls and quantity of loans falls

Explanation

The demand curve shifts right. With an upward-sloping supply curve, a new intersection occurs at a higher price (interest rate) and a higher quantity. A fall in quantity would need a supply shift left.

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