Question

17. Consider a competitive economy in which factor prices adjust to keep the factors of production fully employed. In addition, the interest rate adjusts to keep the supply and demand for goods and services in equilibrium. The economy can be described by the following set of equations: Y=C+I+G C=C(Y-T) I-I(r) Suggest at least two policies that a government could use to increase the equilibrium quantity of investment in the economy and carefully explain how these policies produce this result.

This is a macroeconomics problem. Thanks!

Answer 1

The government can use the following two policies to increase the equilibrium quantity of investment in an economy:

1. Tax Rebates - Government can provide tax rebates to companies that are investing their money in capital technology to improve overall productivity. The government should reduce corporation taxes for companies undertaking investments on a large scale. This will increase profits of the firm in the long run and thus they will invest more money in improving productivity because of the tax rebates offered by the government.

2. Increase in government spending on infrastructure: The government should increase their spending on infrastructure which will increase overall level of national output in the economy and thus aggregate demand will increase and firms will have to increase their spending and thus investment level in the economy will rise.

The above two measures by the government can help in raising equilibrium level of investment in the economy.