Question

7. Mankiw suggests that government policies (such as taxes, subsidies, or environmental regulations)
affect business investment. What examples have we seen in recent years? Select one of those
examples and trace through the steps of how business investment is ultimately affected.

Note : Refer from book MACROECONOMICS, by N Gregory Mankiw

Answer 1

7.

The recent example can be drawn as the government's fiscal policy after 2008 financial crisis, when an increase in spending affected the business environment. Increase in government spending has increased the demand in the market. To cater the demand, firms have to increase the supply and they have to make investments. As a result, business investments also increase. It creates new jobs and economy starts growing. Though, it can be said that there is a crowding out effect that could diminish private investments. But, carefully planned government spending can reduce the negative impact and business investments grows.

In more recent example, the tax reforms have been done under the Trump administration. It has reduced the tax rates and increased the disposable income. It will stimulate the demand (AD) that will cause business investment to increase the create supply (SRAS) that can satisfy the demand (AD). So, the government can use its policies to affect the business investments. These policies can be supply side or demand side policies.