Question

Scenario 1: Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is a decrease in the tax rate on interest income, from 20% to 15%.
This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to ____ and the level of investment spending to ____ .

Answer 1

Answer:

This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to DECREASE and the level of investment spending to INCREASE.

Explanation:

Since the tax rates on savings decreased, more money will be available for saving which will increase the supply of loanable funds. When the supply of any good or services increases, its price decreases. In this case, the price of money is the interest rate.

Since the interest rate decreases, the total quantity demanded for loans will increase, increasing the level of investment spending.