Question

The economy begins in equilibrium at Point E, representing the real interest rate, r1, at which saving, S1, equals desired investment, I1. What will be the new equilibrium combination of real interest rate, saving, and investment if there is a tax law change that makes investment projects less profitable and decreases the demand for investment goods (but does not change the amount of taxes collected in the economy)?

Answer 1

reduction in investment, savings and interest rate

Step-by-step explanation:

A change in factors other than the interest rate causes a shift in the investment demand curve also known as IS curve. The change in tax law which reduces the demand for investment goods will cause the IS curve to shift left from IS1 to IS2 this will shift the equilibrium from E to E1. This will reduce the real interest rate from R1 to R2. A decrease in interest rate will also decrease the saving from S1 to S2 and Investment is already reduced from I1 to I2.

Note: Graph file is attached