Question

Assume that the substitution effect is large relative to the income effect. If a tax reform is designed to increase saving, what does it do to the interest rate and spending on capital goods?

a.

It increases the interest rate and decreases spending on capital goods.

b.

It increases the interest rate and increases spending on capital goods.

c.

It decreases the interest rate and increases spending on capital goods.

d.

It decreases the interest rate and decreases spending on capital goods.

Answer 1

Answer:

a.

It increases the interest rate and decreases spending on capital goods.

Explanation:

Tax reform is a process through which most government controls the spending on capital goods and encourage local goods purchases. This is accomplished through increase on the taxes on those goods in such a way that, it becomes highly discouraging to spend such amount on it thereby encouraging savings.