Question

Suppose government puts a tax on investment at rate τ. That is, you get only 1 − τ apple tree next period if you invest one apple this period. Derive the investment demand equation. What would be the effect of this tax on net exports and real exchange rate in an open economy in long run and very-long run? Explain in detail by showing the changes in the relevant markets.

Seriously?! thats how the question is asked in the assignment! i expect an answer for this asap!

Answer 1

As the government has imposed taxation on the investment, the incentive for a person to invest will gradually be less than what he normally would.The tax would be decentive an investor to invest as the returns would be lower than expected. The tax will be having an adverse effect on investment, savings as well as consumption. There will be a domino effect due to this additional tax, the production would tend to lower in the short run. Eventually, in the long run and in a very long run, the effects depends on the incetives that the investors will be benefitting from and based on that they will evaluate their deficit effect.As the additional tax will reduce investment, so will the exports and therefore there will be an adverse effect on the net exports of the economy.

In the monopoly market, there won't be much changes as there is a sole investor for producer of goods and services and the consumers won't have much choices and therefore the additional tax won't have much effect on the net exports in the long run. In a competitive market, there will be multiple investors and so will be the producers for goods and services therefore there won't be much effect on the goods and services produced and exported.