Tax Break for Savers
The question
The legislature of Nordhaven eliminates the tax that households previously paid on the interest they earn from bonds and savings accounts, so savers now keep every dollar their funds earn. Assume firms' desired investment at each real interest rate is unchanged, and assume the government trims its own spending by exactly the revenue it gives up so that its budget balance is unchanged. Show the effect of this policy in Nordhaven's loanable funds market. Show the effect on the Loanable Funds Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Tax Break for Savers: the worked answer
On the Loanable Funds Market graph, Supply of loanable funds shifts right.
Why Supply of loanable funds shifts right
Taxing interest income reduces the reward households actually receive for lending their funds. Removing that tax raises the after-tax return households earn at every market real interest rate, so they are willing to save and lend more, and the supply of loanable funds shifts to the right. Firms' desired investment and the government's budget balance are unchanged by assumption, so the demand for loanable funds does not move.
What happens to the equilibrium
The equilibrium real interest rate falls and the equilibrium quantity of loanable funds increases.
The mistake students make on this one
The most common error is to draw no shift at all and simply slide up the existing supply curve, on the grounds that savers are now earning more. The rate on the vertical axis has not changed; the policy changes how much households save at each of those rates, and a change at every rate is a shift of the whole curve.
On exam day
Only a change in the variable on the vertical axis produces a movement along a curve. A tax that changes what savers keep at every one of those rates shifts the curve, and on this graph an answer that moves nothing is scored as wrong.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Supply of loanable funds shifts right and every other curve on the Loanable Funds Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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