Q. Suppose the Government increases taxes and this leads to a decline in the disposable income. What happens to household savings and the real interest rate in the short run, and potential output in the long run?
1.Household saving decreases
2.real interest rate increases
3.Potential output decreases
Select the correct answer using the code given below:
Answer: D
Notes:
Less income after tax income decreases the ability to save, decreasing the supply of loanable funds and increasing the interest rate. Higher interest rates reduce the incentive for firms to create new capital, so as the existing stock of capital depreciates, the stock of capital decreases which decreases potential output.
Source- Article
