Question

select the correct answer.
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.

Explanation:

When tax rates increase, people's disposable income (income after tax) decreases. Since savings come from disposable income (as people save a part of their disposable income and consume the rest), a decrease in disposable income will lead to a decrease in savings. In a closed - economy model (or even in an open - economy context with domestic investment considerations), savings are a major source of funds for investment. If savings decrease, the amount of funds available for investment will also decrease, so investment will decrease.

Answer:

A. Savings decrease, and investment decreases.