In a certain economy, people save some part of their income in the financial sector and use the remaining part for consumption.
The government decides to increase the tax rates for everyone in that economy. What effect will the tax increase have on savings and investment in the economy? A) Savings decrease, and investment decreases.
B) Savings increase, and investment increases.
C) Savings increase, and investment decreases.
D) Savings decrease, and investment increases.
Option A, Savings decreases and investment decreases, is the right answer.
Explanation:
The imposition of tax will decrease the disposable income because disposable income is the one that remains after paying the direct tax and this disposable income is further saved or consumed. However, tax and disposable income are inversely related. Therefore, if disposable income decreases then saving also decreases. Moreover, investment depends on saving. Thus, if the tax rate leads to a decrease in savings then the investment will also decrease
