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If the Federal Government increases taxes: What will be the effect on money demand, money supply,...

If the Federal Government increases taxes:

  1. What will be the effect on money demand, money supply, and interest rates? Please explain.
  2. What will be the effect on planned investment, AE, and GDP? Please explain
  3. In the short-run: What will be the effect on AD and SRAS? What will be the effect on prices? Please explain.
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Answer #1

With increase in taxes, there is decrease in disposable income. Thus, demand for money decreases, money supply remains same and interest rate further decreases.

Planned investment increases with decrease in interest rate, aggregate expenditure by people falls as their disposable income goes down and output decrease and so does GDP.

With the increase in taxes, disposable income decreases thus aggregate demand decreases and aggregate demand curve shifts leftward. SRAS will have no effect with increase in taxes. Thus price level will decrease.

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