Question

29. Suppose the government of a small open economy passes an investment tax exemption to stimulate investment. Using the classical open economy model from chapter 6, what will the effects of this investment tax exemption?

Answer 1

Ans.

- Open economy is an economy that trades with other countries. If there are no restrictions on trade, then members of an open economy can buy and sell goods and services at the price prevailing in the world market, the world price. An open economy can provide domestic households with a larger variety of goods and services, give domestic companies access to global markets and customers, and offer goods and services that are more competitively priced.

- For capital intensive industries, such as automobiles and aircraft, manufacturers can take advantage of economies of scale because they have access to a much larger market.

- In addition, it can offer domestic investors access to foreign capital markets, foreign assets, and greater investment opportunities.

- When a small open economy passes an investment tax exemption to stimulate investment ,it will attract lot of foreign direct investment.

- This will increase the capital available for the local businesses and industries in the small open economy and the cost of capital will come down . This will increase the supply, employment and demand for the products and increase the GDP of the country and improve the foreign reserves for the small open economy.