# how lowering the effective tax rate on capital (τ) will work (in theory) its way

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Question description

Now we are going to focus on the idea that in the longer run, the influence of the decrease in the effective tax rate on capital will have ‘supply-side’ effects.  In particular, we argue that this new investment, spurred on by the lower effective tax rate on capital, will result in a positive productivity shock resulting in a higher “A and K" which will result in a shift upward in the production function (via increasing the MPKf and MPN….these are the supply side effects) In the space below draw a production function with the labor market diagram directly below it and show what is going on in this longer run. That is, locate the corresponding point B (from above), and then show the longer run influence as point C in these two (supply – side) diagrams.  What happens to N* and w*=W/P? Explain in detail. Are these results in the labor market consistent with sub-title of the article and the business cycle facts?  Now explain why output has changed, give two specific reasons. Note, in this part of the problem, do not worry about identifying point A in the labor market diagram and production function diagram since point A does not exist given the assumption that labor markets always clear at full employment (i.e., a weakness of the classical model). Be sure to label your graphs completely (relevant shift variables) or points will be taken off.

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