A year ago a country reduced the tax rate on all interest income from 20% to 10%.During the year private saving was $500 billion as compared to $400 billion the year before the tax reform.Taxes on interest income fell by $10 billion.Assuming no other changes in income,or government revenues or spending,which of the following is correct?
A)the substitution effect was larger than the income effect;national saving rose
B)the substitution effect was larger than the income effect;national saving fell
C)the income effect was larger than the substitution effect;national saving rose
D)the income effect was larger than the substitution effect;national saving fell

Question

Quizplus · Accepted Answer

The substitution effect encourages saving, while the income effect discourages saving. Since national saving rose, the substitution effect must have been larger than the income effect.

A Year Ago a Country Reduced the Tax Rate on All