Suppose the governments of two different economies, economy A and economy B, implement a permanent tax cut of the same size. Investment spending in economy A is less sensitive to changes in the interest rate than investment spending in economy B. The economies are identical in all other respects. The tax cut will have a smaller impact on aggregate demand in the economy with the a) higher sensitivity to changes in the interest rate, or b) lower sensitivity to changes in the interest rate

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Business

Henry Mendoza

11 March, 00:47

Suppose the governments of two different economies, economy A and economy B, implement a permanent tax cut of the same size. Investment spending in economy A is less sensitive to changes in the interest rate than investment spending in economy B. The economies are identical in all other respects. The tax cut will have a smaller impact on aggregate demand in the economy with the a) higher sensitivity to changes in the interest rate, or b) lower sensitivity to changes in the interest rate

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Steven Copeland · Answer 1

b) lower sensitivity to changes in the interest rate

Explanation:

The tax cut is a renunciation that the government makes so that the money that would be collected is used by society. However, consumption and investment, which are components of aggregate demand, depend on other factors.

The interest rate is considered the price of money since it is the remunerative factor. With money in hand, economic agents decide whether to invest money in the productive sector (consumption and investment) or in the financial sector - to earn interest. Thus, those most sensitive to changes in interest rates tend to invest money in the financial sector.