Why does an increase in business taxes shift the investment demand curve to the left?

• A. Because higher taxes lower the cost of borrowing for firms, making investment more attractive.
• B. Because higher taxes increase the supply of loanable funds, shifting the investment demand curve to the left.
• C. Because higher taxes reduce the expected profitability of investment projects, making firms less willing to invest at any given interest rate.
• D. Because higher taxes increase consumer demand, encouraging firms to invest more.

Answer: (C)

Verified step by step guidance

1. Understand the investment demand curve: it shows the relationship between the quantity of investment firms want to undertake and the interest rate, holding other factors constant.
2. Recognize that business taxes affect the expected profitability of investment projects. Higher taxes reduce after-tax returns, making investments less attractive.
3. Since investment demand depends on expected profitability, a decrease in profitability means firms will want to invest less at every interest rate.
4. Graphically, this reduction in investment demand shifts the investment demand curve to the left, indicating a lower quantity of investment demanded for any given interest rate.
5. Note that the cost of borrowing (interest rate) and supply of loanable funds are separate from the direct effect of taxes on profitability; higher taxes do not lower borrowing costs or increase loanable funds supply in this context.