Answer to Question #111627 in Macroeconomics for Anshika

Question

China’s government exempted the micro, small and medium-size enterprises from making employer contributions to pension and work-related injury insurance schemes. Also, allowed the larger enterprises to reduce the same by 50%. (Hint: It will have a direct impact on the cost of employment, or can say will ease enterprises’ cash-flow constraints.) What will happen to the output in China using IS-LM framework.

Answer 1

Of course, for enterprises this is cheaper labor force. Personnel costs will decrease significantly.

Additional cash resources will appear at enterprises, this will facilitate cash flows.

Suppose the state reduces taxes by ΔТ. In this case, the IS curve is shifted to the right by a distance equal to:

∆T * (MPC / (1 - MPC)) (2.1)

where ∆Т is the amount by which taxes will be reduced

(MPC / (1 - MPC)) - tax multiplier.

The equilibrium moves from point A to point B. Tax cuts increase income from Y1 to Y2, and the interest rate also rises from r1 to r2.

Thus, the fiscal policy of stimulating the economy increases the interest rate and crowds out part of investment spending.

Thus, part of the funds is being secured from enterprises, but as a result of the state’s decrees to reduce the tax burden, the interest rate will increase, money will rise in price, which will reduce investment income, worsen the investment climate.