Raises taxes on business profits causing investment to fall

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There is an error in economic reasoning in each of the following statements. Identify it and explain what is wrong.

1. The government raises taxes on business profits causing real investment to fall. This occurs because businesses find expansion in plant and equipment less attractive when profits are reduced. The reduction in real investment decreases short-run aggregate supply (shift to the left) thereby reducing output and raising prices.

2. A major hurricane wipes out significant amounts of crops and destroys numerous plants, stores, and other businesses. This shows up in the economy as a reduction in short-run aggregate supply (shift to the left). The result is a smaller equilibrium output and a higher price level. The higher price level, however, prevents some former customers from demanding as many goods, so the aggregate demand becomes smaller (shifts left), reducing equilibrium output even further.

Reference no: EM131097803

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