Short run effect of increase in tax and long run effect of adjusting real interest rate.

Question

Want to see more full solutions like this?

Answer 1

Question

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Students have asked these similar questions

What happens to the money supply when the Fed buys government bonds? According to the theory of liquidity preference, what is the impact of the Fed action on the equilibrium interest rate?

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________. A) it would likely conduct a tightening of monetary policy by raising the real interest rate for any given inflation rate B) it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate C) it would likely conduct an easing of monetary policy where the real interest rate would increase due to the ensuing decrease in aggregate demand D) it would likely conduct a tightening of monetary policy where the real interest rate would increase due to the ensuing increase in aggregate demand E) none of the above

What is the key assumption underlying the Fed’s abilityto control the real interest rate?

Answer 2

Question

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Question

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Question

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Answer 6

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Answer 7

Chapter 14, Problem 1RQ

To determine

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Answer 8

Expert Solution & Answer

Explanation of Solution

When the tax rate increases, the disposable income of the people will decrease, which in turn reduce the aggregate demand and cause shift in the AD curve to the left. As a result, GDP also will fall, which will create a recessionary gap in the economy; in turn, the inflation rate will decrease. The firms sell lesser quantity of output than they are willing to sell, which causes a rightward shift in the short run aggregate supply (SRAS) curve. This will lead to reducing price of the commodity. The firm decreases SRAS, until the short run supply curve equates the aggregate demand (AD) curve at the potential GDP level and actual inflation will fall.

Suppose, the Fed decided to adjust the real rate of interest in which investment and savings are equal. In the economy, there is higher level of taxation, which implies that the government has higher saving at the given level of spending. In order to stabilize the investment, the Fed will reduce the current rate of interest. As real rate of interest decreases, cost of borrowing decreases, which is an incentive for investment. As a result, new employment opportunities will increase and production increases. Hence, the aggregate demand also increases, which shifts the AD curve to the right. This offset the leftward shift of the AD curve occurred due to the increased tax rate. Accordingly, the total GDP will reach at the potential level, but the inflation rate will be much higher than the initial level.

Answer 9

Expert Solution & Answer

Answer 10

Expert Solution & Answer

Answer 11

Economics Concept Introduction

Aggregate demand (AD): Aggregate demand refers to the total value of goods and services that are demanded at a particular price in a given period of time.

Answer 12

Ch. 14 - Prob. 1RQ Ch. 14 - Prob. 2RQ Ch. 14 - Prob. 3RQ Ch. 14 - Prob. 4RQ Ch. 14 - Prob. 5RQ Ch. 14 - Prob. 6RQ Ch. 14 - Prob. 1P Ch. 14 - Prob. 2P Ch. 14 - Prob. 3P Ch. 14 - Prob. 4P

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Short run effect of increase in tax and long run effect of adjusting real interest rate.

Explanation of Solution

Want to see more full solutions like this?

Chapter 14 Solutions