Question

Suppose Congress passes an investment tax credit that increases the quantity of investment goods that firms...

Suppose Congress passes an investment tax credit that increases the quantity of investment goods that firms demand at any given interest rate. Which of the following would you expect to occur as a result of this change?

a.

​In the short run, unemployment will increase and inflation will rise.

b.

​In the short run, unemployment will decrease and inflation will rise.

c.

In the short run, unemployment will increase and inflation will fall.

d.

​In the short run, unemployment will decrease and inflation will fall.

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Answer #1

Through investment tax credit, the Congress tries to subsidize the investment in goods. Increase in the demand for investment goods will shift the demand for loanable funds to right.

Rightward shift in the demand curve will create an upward pressure on the price level.

According to the Phillips curve, there exists a short run trade-off between inflation and unemployment. A rise in the inflation leads to fall in the unemployment.

So, Option a. and d. are incorrect.

There will be an increase in the inflation and therefore unemployment will decrease.

So, Option b. is the correct choice

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