Question

6. Tax systems and saving This question addresses the impact of saving on an economy by examining what happens if tax laws change to induce saving and how changes in tax laws can discourage saving. The following graph shows the market for loanable funds. Show the impact of a change in the tax law that successfully encourages saving by shifting either the demand curve (D), the supply curve (S), or both. S D s INTEREST RATE D LOANABLE FUNDS A tax law change that successfully encourages saving will decrease interest rates, which leads to more investment and economic growth. To understand better how changes in tax laws can affect saving, imagine that Eric, a student, plans to save $400 from his summer job to buy textbooks next autumn. Eric's parents are so impressed with his plans that they offer to pay him an additional 25% interest per month on the money he saves, which means that Eric is now earning a large rate of return on his saving. It turns out that Eric saves $450 (before the interest paid by his parents) from his summer job. This means that the effect must be smaller than the effect for Eric in this case.

Answer 1

in erics case savings is greater than taxable income. so here income or savings get increasses , this means that savings effect is smaller than the paradox of thrift effect