3 Using a Keynesian model of an open economy explain what ha

3. Using a Keynesian model of an open economy explain what happens to Y, L, K, W/P, C, I, r, i, P, MD (Money Demand), e, E, Nx(Net exports) when the government cuts taxes. Please explain the intuition behind the changes in variables as well as the proper order in which they change.

Solution

Ans

As taxes are cut, consumption and income rises. Money demand rises and so does r and i. At the same time demand for labour l and k rise due to greater investment. So w/p rises which again pushes consumption up. This pushes p up.