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. TY. LOANABLE FUNDS A tax law change that successfully encourages saving will interest rates, which leads to investment and economic growth. To understand better how changes in tax laws can affect saving, imagine that Alex, a student, plans to save $500 from his summer job to buy textbooks next autumn. Alex'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 Alex is now earning a large rate of return on his saving. It turns out that Alex saves $600 (before the interest paid by his parents) from his summer job. This means that the effect must be smaller than the effect for Alex in this case

Answer 1

TY. LOANABLE FUNDS

A tax law changes that successfully encourages saving will decrease interest rates, which leads to more investment and economic growth.

To better understand how changes in tax laws can affect saving, imagine that Alex, a student, plans to save $500 from his summer job to buy textbooks next autumn. Alex'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 Alex is now earning a large rate of return on his saving. It turns out that Alex saves only $600 (before the interest paid by his parents) from his summer job. This means that the Substitution effect must be smaller than the Income effect for Alex in this case.