Author Question: What is the tax wedge? What will be an ideal response?[br][br][b][color=#9E3EA8]Question ... (Read 53 times)

sheilaspns · **on:** Jun 29, 2018

What is the tax wedge?

What will be an ideal response?

Question 2

Is fiscal policy more or less effective in manipulating aggregate demand in an open economy?

What will be an ideal response?

Eazy416 · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The tax wedge is the difference between the pretax and posttax return to an economic activity.

Answer to Question 2

Expansionary fiscal policy (as from tax cuts or increases in government spending) will increase aggregate demand. However, expansionary fiscal policy can result in higher interest rates if government or private saving falls as a result of expansionary fiscal policy. The higher interest rates reduce not only consumption and investment, but they also reduce net exports. That is, the crowding out effect may be much larger than in the case of a closed economy. Because the impact of expansionary fiscal policy has a negative impact on net exports that does not exist in a closed economy, fiscal policy has a smaller impact on aggregate demand in an open economy than in a closed economy.