Assuming that the substitution effect is large relative to the income effect,tax reform designed to increase saving
A)increases the interest rate and decreases spending on capital goods.
B)increases the interest rate and increases spending on capital goods.
C)decreases the interest rate and increases spending on capital goods.
D)decreases the interest rate and decreases spending on capital goods.

Question

Quizplus · Accepted Answer

When the substitution effect is larger than the income effect, an increase in saving could lead to a decrease in consumption. This could result in a decrease in the demand for goods and services, which lowers interest rates. Lower interest rates make saving less expensive, and borrowing more attractive, leading to an increase in spending on capital goods. Therefore, tax reform designed to increase saving would decrease the interest rate and increase spending on capital goods.

Assuming That the Substitution Effect Is Large Relative to the Income