Question

Suppose an Individual Retirement Account (IRA) has a contribution limit of $4,000 per year and that prior to the passage of the law establishing IRAs, Rachel was saving $5,500 per year. Which of the following is the most likely effect? A) The income effect of the tax subsidy will cause her to save more. B) The tax subsidy in the IRA will have an inframarginal effect on Rachel's saving. C) The substitution effect of the tax subsidy will induce Rachel to save less. D) The tax subsidy in the IRA will have no effect on Rachel's decision to save.

Answer 1

ANSWER:

The correct answer is c because since the limit has been put up to $4000 , therefore she will have $1,500 extra to spend or to invest which means she is likely to save less.

a cannot be the right answer because of the $4000 limit , so she will have extra money to spend as government wants her to invest or spend in the market and not save in her retirement fund.

b cannot be the right answer because the question doesn't talk about tax savings on giving charity as that is what is inframarginal effect .

d cannot be the right answer because of the extra $1500 dollars she will have now and therefore she is likely to spend or invest , rather then do nothing about it.