Assume that the economy’s output ratio equals 100 and monetary policymakers will react to any change in fiscal policy so as to prevent a rise in either the unemployment rate or the inflation rate. For each of the following changes in fiscal policy, explain what is likely to happen to the user cost of capital, the desired ratio of capital to expected output, and the level of net investment. Finally, keep in mind that any change in investment expenditures shifts the IS curve and affects aggregate demand.
(a) Defense spending declines due to an increase in political stability across the globe.
(b) Personal and corporate income tax rate cuts are passed in conjunction with even larger decreases in government spending.
(c) An investment tax credit is enacted with no other changes in fiscal policy.
(In/Y)
(d) Federal spending on health care is increased and is only partially paid for by a higher tobacco tax.
(e) Explain how any of your answers to parts a–d might change if the output ratio were less than 100.