(Exhibit: Saving, Investment, and the Interest Rate 1) Reference: Ref 3-1 (Exhibit: Saving, Investment, and the Interest Rate 1) 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 the government raises taxes, holding other factors constant?

Question

(Exhibit: Saving, Investment, and the Interest Rate 1)

Reference: Ref 3-1

(Exhibit: Saving, Investment, and the Interest Rate 1) 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 the government raises taxes, holding other factors constant?

Quizplus · Accepted Answer

If the government raises taxes, it will reduce disposable income and decrease consumption, leading to a decrease in desired investment. This will shift the investment curve to the left from I₁ to IS2U1B11S2U1B0. The equilibrium point E will no longer be possible, and a new equilibrium point must be found where saving equals the new desired investment. This new equilibrium point will be at point B, where the real interest rate is higher than at point E, and both saving and investment are lower.