Assume an economy is closed. According to classical economic theory, explain wha

Question

Assume an economy is closed. According to classical economic theory, explain what will be the long run effects of an increase in taxes.You may want to organize your answer around these three parts: A) Aggregate Supply/Output (includes a discussion of the determinant of the level of output and the effect of fiscal policy on output in the long-run B.Aggregate Demand/Real expenditures (includes a discussion of components of expenditures, their determinants, and the effect of fiscal policy on expenditures and the composition of expenditures). C. Loanable Funds Markets (includes a discussion of the determinant of the interest rate in loanable funds market and the effect of the fiscal policy on the real interest rate in the long run). Please include a graph if possible.

Explanation / Answer

A & B) An increase in tax shifts the aggregate demand curve to the left because the spending decision of firms or household is influenced by increase in tax. The consumers will to spend less as a result of increase in tax. When the tax rate increases the worker have less dollars they earn, so they have less incentive to work and produce the goods/services.Hence, we can say that the aggregate supply curve shifts to the less as they respond less when tax is high.
C) Generally, the output is determined by the supply of labor and capital and also the available technology for converting the labor hours used and capital used into output. So, for any given level of output the interest rates adjusts automatically to balance the supply and demand of loanable funds.

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