a) (30 POINTS) In this part you are to explain exactly how lowering the effective tax rate on capital (τ) will work (in theory) its way through the economy in order to “spur growth and raise wages.” In this discussion, you need to differentiate between the short- run and long-run. In the space below, explain, with graphical analysis, how lowering the effective tax rate on capital will influence real economic variables in the short run (hint, it’s a demand side story). Draw 4 diagrams (label them 1 through 4), with 1) a user cost ; desired capital (K*) diagram, followed by 2) a closed economy desired saving; desired investment diagram, followed by 3) an IS – LM diagram followed by 4) an aggregate supply ; aggregate demand diagram.
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