For the question 'Explain how a reduction in corporation tax on firm's profits might lead to supply side improvements in the economy'
Received 8 out of 9 marks.
Explain how a reduction in corporation tax on a firm's profits might lead to supply side
improvements in the economy (9 marks).
Supply side improvements are when firms have a desire to increase output, resulting in increases
in productive capacity. Corporation tax is a tax on the profits earned by companies, in the UK
companies are taxed 19% on up to £300,000 on their profits in the UK.
A reduction in corporation tax will mean that firms will be incentivised to carry out more
investments. As corporation tax reduces, firms will have more of their profits available to use for
investments. As firms invest in areas of machinery and training for their workers, this will
increase productivity. If firms invest in training for their workers, this means that their workers
will have a greater set of skills, which can lead to lower
structural unemployment. By increasing the quantity of
training and improving the quality of training, the
productivity of firms rises leading to an increase in output.
This overall leads to an increase in productive capacity.
This is shown in the Classical LRAS diagram as the LRAS
curve shifts right from LRAS1 to LRAS2, leading to an
increase in real GDP in the economy, shown as Y1
increases to Y2. This increase in real GDP leads to an
increase in living standards and quality of life. The increase
in investment leads to an increase in aggregate demand as it
is a component of the AD equation. As investment
increases, there is more money flowing in the economy. This means as investment increases the
amount of output produced increases without an increase in inflation. This is shown as the
AD/LRAS diagram, as AD shifts right from AD1 to AD2, real GDP increases but inflation stays
the same. Leading to higher productivity, quality of life, and standard of living. Therefore
displaying how a fall in corporation tax on a firm’s profits can lead to supply side improvements
in the economy.
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