Question

Use IS-LM-PC framework to answer this question. Assume the country is in equilibrium, with output at potential and inflation stable. Suppose the Government decides to provide tax concessions for businesses to support the economic growth. What will happen in the medium term to inflation, output and investment?

Answer 1

When government give tax concession it means that there is reduction in tax rate. Reduction in tax rate means that the disposal income of the people increases. When disposal income of the people increases people spend more on their consumption and investment also rises because the saving of the people increases due to increase in disposal income.

The consumption and investment in the economy it affect the IS Curve and IS Curve shift right ward. When IS curve shift right ward it due to which Output level increases, investment level increases and inflation rate is also increases due to generation of more output and employment in the economy. But this inflation rate is adjusted in the economy and it is benefical for the economy to the generation of more employment in the medium term.

So we can say that due to government tax concession the output, investment and inflation rate increases in the medium term.