1. The government of an economy has increased its spending and its taxes by the same amount....

1. The government of an economy has increased its spending and its taxes by the same

amount. What is the effect on investment? Use the long-run model of the economy

developed in Chapter 3.

Expert Solution

Investment would increase, since the government spending (G) increases. The effect of an increasing tax (T) would be on the consumption, which will be reduced; but, the overall aggregate demand (AD) would increase. This is so because a spending effect becomes higher than the tax effect, since the implication of tax depends on MPC.

It creates an inflationary gap.

Rahul Sunny answered 2 years ago

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