Question

Suppose the law is changed so that innovation activities by firms are taxed at a much lower rate than other company expenses.

a. What happens to the long-run aggregate supply curve? Explain.

b. What happens to the value of the dollar? Explain.

c. What happens to the quantity of net exports demanded? Explain.

d. What happens to aggregate demand? Explain.

Answer 1

a. Longrun aggregate supply relates to the maximum productive capacity of an economy. When productive capacity increase due to improvement in technology or increase in natural resources or labour and capital, the potential output of the economy increase and the longrun aggregate supply curve shift to the right. Low tax on innovation will promote the supply of more efficient and technologically sophisticated machines and equipments. This will improve the productive capacity of the economy. As productive capacity increase aggregate supply increase and the longrun aggregate supply curve shift to the right.

b. The country will export more as its productive capacity increase. The increased export will create more demand for dollar. The value of dollar will appreciate in the international market.

c. An increase in domestic supply will reduce the domestic price level. A lower domestic price makes the domestic products more competitive in the international market. The demand for export increases. At the same time the demand for import decreases since the foreign goods are now costly in the domestic market. Thus increased export and decreased import increases the net export.

d. A lower price in the domestic market increases the consumption demand. Again the increased demand from the rest of the world also increases the aggregate demand in the nation.