Question

1.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?

Suppose a government decides to increase taxes.

2.Using the long-run model of the economy developed in Chapter 3(national income), graphically illustrate the impact of on GDP. Be sure to label the axes, the curves, the initial equilibrium values, the direction curves shift, and the terminal equilibrium values.

Answer 1

Classical open economy model: The classical model of the economy says that, there is full employment in the economy all the time and prices and wages are flexible. If the unemployment situation is arises it just because of rigidities of market such as minimum wages, pressure of trade unions. Government purchases can be increase in the classical economy model with effect of exchange rate of country due to change of imports and exports. What will the effects of investment tax exemption? Investment is a tax exempt security in which production of income is free from state tax, local tax and from federal. Municipal bonds also come in the form of tax exempt securities and represent the municipality and state obligations. Some of the investors, U.S bond interest savings also exempted from the federal income taxes. For general rule tax exemption is an important then the absence of taxation in the some type of conditions. Government decided to increases the taxes: If the government increases the amount of taxes for social welfare, it will affect the economy as whole for example aggregate demand will decrease due to high rate of taxes and vice versa. Long run model of national income impact on the GDP: MEANING OF NATIONAL INCOME: The value of goods and services produced by a country during the financial year is termed as national income. There are two definition of national income: Traditional definition Modern definition: GDP, GNP GDP: GDP means the gross national product which is produced with in the country. The various constituents of GDP: rent, wages , salaries , mixed income, direct taxes, dividend, depreciation, etc.

APL LRAS SRAS Ple 0 Yp Ye Real GDP In this diagram, Here APL is Above the Poverty line, LRAS: The long run aggregate supply curve, AD is Aggregate demand curve. In this figure real GDP is find and it states that the goods are produced and demanded within the country.