Answer to Question #116589 in Macroeconomics for Sanya

Question

Explain the effect of investment subsidy on equilibrium interest rates
, consumption, investment and GDP
compare the result with other fiscal policy measures

Answer 1

Subsidies refer to financial aid given to businesses or customers in order to boost sales. They are used whenever there is a shortage in supply, to encourage the purchase of safety or healthy products, or whenever it is in the best interest of the public .Subsidies are mostly provided by the government.

Subsidies have very many effects some social, economic and even political .We are going to look at the effects of investment subsidy the following;

1)     Equilibrium interest rates.

2)     Consumption.

3)     Investment.

4)     Gross domestic product (GDP).

1)     Equilibrium interest rates

This is the interest rate that occurs at the point where the demand for of money is equal the supply of money. Equilibrium interest rate of the demand for money curve and the supply of money curve intersects .This point is said to be the equilibrium point. The equilibrium interest rate have an impact on the economy and monetary policy this is because as income increases, the demand for money increases. As a result the equilibrium interest rate goes up. When the Federal Reserve sets an interest rate higher than the equilibrium interest rate, the supply of money is greater than what individuals want to retain in cash.

When the interest rate is lower than the equilibrium interest rate, the amount of money in circulation is not enough for households. This will create a gap to increase the supply of money.

2)     Consumption Subsidies.

Government provides subsidies to consumers to encourage the purchase a product. If a customer wants to buy a product but due to higher costs became discouraged. Subsidies are provided to the consumer for each product they buy, providing further incentive. The demand curve shifts to the right because at any price, consumers are more willing to buy because of the rebate. There will be increase in sales. The price will rises as a result of the higher demand, producing even greater profits for manufacturers and business owners. The supply curve will not change its position but the quantity demanded changes. Where the new demand curve meets the increased quantity supplied is the equilibrium point.

3)     Investment subsidy

If the government provides a subsidy for spending on production facilities such as buildings, machines and equipment firms will borrow more money .This can be due to the interest rate of borrowing loans from banks is low. Since people have invested in various sectors of the economy jobs more will be created .The subsidies offered on investment are very crucial people will be willing to invest which also creates revenue for the government inform of taxes .The demand curve will therefore shift to the right .

4)     Gross domestic product (GDP).

Gross Domestic Product refers the value of economic activity within a country. Subsidies increases the government expenditure and as a result it will tend to borrow more .This results to the government increasing its taxes .When calculating GDP subsidies are not included because they are not used as a payment of goods and services but as an aid to the economy. People will not have cash in their pockets because more money is used in the aid of certain projects and services.