QUESTION Consider an economy where the government\'s budget is initially balance

Question

QUESTION Consider an economy where the government's budget is initially balanced. The production function, consumption function and investment function can be represented as follows C Co+b(Y- T lo- dr Suppose that taxes increase. What happens to the equilibrium level of output? increases O decreases remains same O cannot be determined QUESTION Consider an economy where the government's budget is initially balanced. The production function, consumption function and investment function can be represented as follows C Co+b(Y- T lo- dr In the long run, an increase in investment demand will lead to O an increase in national savings and investment O a decrease in national savings and investment O a decrease in national savings and an increase in invesment O none of the above

Explanation / Answer

1) When taxes increases there is a budget surplus or government exoenditure falls with respect to income . Also when taxes increases disposable income (Y - T ) falls since people have less money in hand to spend . Consumption expenditure falls . Hence , equilibrium level of output decreases .

2) We know that in a closed economy , investment is equal to savings at equilibrium . So in long run an increase in investment demand would lead to more savings since an increase in investment demand causes rise of interest rate in short run . So in long run , this high interest rates attracts more savings which ultimately balances the economy . So it causes an increase in national savings and investment .

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