Question

Suppose a government that taxed all interest income changed its tax law so that the first $5,000 of a taxpayer's interest income was tax free. This would shift the...

a. supply of loanable funds to the right, causing interest rates to fall.

b. supply of loanable funds to the left, causing interest rates to rise.

c. demand for loanable funds to the right, causing interest rates to rise.

d. demand for loanable funds to the left, causing interest rates to fall.

Answer 1

The correct answer is option a.

Step-by-step explanation:

Suppose the government used to tax incomes.

But a change in law will exempt tax for the first $5,000 of interest income.

This means that the income from providing loans will increase and the cost of supplying funds will decline. This will cause an increase in the supply of loanable funds. As a result, the supply for loanable funds curve will shift to the right. This rightward shift will cause the interest rate to fall.