Question

Q4 (14 points) For each of the following changes, determine the effect on the aggregate demand curve and the short-run aggregate supply curve, as well as the effect on the aggregate price level and aggregate level of output. a. (3 points) Government reduces taxes b. (4 points) Government reduces taxes at the same time that nominal wages fall c. (3 points) Households' real wealth increases d. (4 points) There is an increase in precautionary demand for money by households

Answer 1

a) If the government reduced the taxes in the market then the aggregate demand curve will shift to the right and the new equilibrium will be at a higher price and higher output. this will only cause a movemennt along the SRAS curve.

b) This will shift the AD curve to the right when the taxes are reduced and as the nomina wages fall the SRAS will shift to the right, the new equilibrium will be at a higher output in the market and the price change is indeterminant.

c) This will just shift the AD cruve to the right and not affect the SRAS the new equilibrium will be at a higher price and higher output in the market.

d) This will reduce the consumption and shift the AD curve to the left, the new equilibrium will be at a lower price level and lower output