Magnitudes of the substition and scale effects


Problem:

Congress frequently considers proposals to reduce the rate at which capital gains are taxed (i.e. lowering the costs of capital). Proponents believe that the reduced capital gains tax rate would encourage businesses to expand and hire more workers. Opponents argue that such a tax cut would primarily benefits stockholders. Although it is an important aspect of the debate, for the purposes of this question, you may ignore the effects that the proposed tax cut would have on the federal governments budget deficit.

a) Do proponents of the capital gains tax cut believe that labor and capital are gross complements or gross substitutes? What do opponents believe about the magnitudes of the substition and scale effects? Support your answer with a graph.

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Finance Basics: Magnitudes of the substition and scale effects
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