Answer to Question #225101 in Macroeconomics for Sara

Question

Consider two alternative programs for contraction. One is the removal of an investment sub-
sidy; the other is a rise in income tax rates. Use the IS-LM model and the investment subsidy shift the investment schedule, to discuss the impact of these alternative policies on income,
interest rates, and investment.

Answer 1

Removal of investiment subsidies will reduce incentives to invest . Rise in income taxes will decrease profits thereby discouraging firms from investing. Investment will shift leftward, decreasing interest rate and decreasing quantity of saving for both cases.

As investment falls, I0 shifts left to I1, intersecting S0 with lower interest rate r1 and lower quantity of saving/investment Q1.

 Interest rate will fall from r0 to r1 as output decrease from Y0 to y1 andc investment Is0 shifts left to Is1.