The economy with the greater sensitivity of investment spending to changes in the interest rate (economy Y) will likely experience a larger impact on aggregate demand from a permanent tax cut compared to the economy with less responsive investment spending (economy Z).
greater sensitivity of investment spending to changes in the interest rate. In this scenario, the effectiveness of a tax cut in stimulating aggregate demand depends on its ability to influence key components of the economy, such as consumption, investment, and government spending.
When a government implements a permanent tax cut, it puts more disposable income into the hands of households and businesses.
This additional income can be spent on consumption or invested in various projects, depending on the responsiveness of these sectors to changes in economic conditions.
In the case of economy Y, where investment spending is more sensitive to changes in the interest rate, the permanent tax cut is likely to have a more significant impact on overall economic activity.
A decrease in taxes can lead to increased disposable income for both consumers and businesses.
For economy Y, the higher sensitivity of investment spending implies that businesses are more responsive to changes in the interest rate, likely resulting in a more substantial increase in investment.
On the other hand, in economy Z, where investment spending is less sensitive to interest rate changes, the impact of the tax cut on aggregate demand may be less pronounced.
While households may increase consumption, the relatively lower responsiveness of investment spending could limit the overall boost to economic activity compared to economy
question:
User
130
120
Aggregate Demand
110
100
PRICE LEVEL
90
Aggregate Demand
80
70
0
10
20
30
OUTPUT
40
50
60
Suppose the governments of two very similar economies, economy Y and economy Z, implement a permanent tax cut of equal size. Investment spending in economy Y is more sensitive to changes in the interest rate than investment spending in economy Z. The economies are otherwise completely identical.
The tax cut will have a larger impact on aggregate demand in the economy with the