Question

Name: For each of the following events, use an AD-AS diagram to show the short-run and long-run effects on output and the price level (inflation rate); identify any output gap. Assume the economy starts in long run equilibrium. (1) The government reduces income taxes AS P AD (2) A decrease in consumer confidence leads to lower consumption spending AS P. AD

What reference?

Answer 1

1) Govt Reducing Income tax----

LRAS AS V > PRICE AD AY YP Ý REALGDP & BILLIONS

Reducing income tax increases disposable income of Consumers and increases AD ( C is part of AD).It will shift AD towards right.

Real gdp Increases

Price level rises

2) Decrease in Consumers confidence leading to lesser Consumption spending

IRAS Aş PRICE LEVEL ($ AD AD REAL GDP ($ BILLION Y'yP

Decrease in consumption leads to leftward shift of AD curve as C is a component of AD.

It will decrease real gdp anc price level

3) Fed decreases the money supply

BILLONS IRAS AS PRICE LEVEL ($) f AD x Y' y REAL GDP ($ BILLIONS)

When fed decreases money supply under inflationary Monetary policy, it reduces borrowing by investors anc consumers,which leads to leftward shift of AD curvr

Real gdp = decreases

Price level falls

4)Oil prices drop sharply

LRAS SRAS SRAS E PRICE CA 인 AD y y REAL & BILLIONS)

With the sharp fall oin oil prices ,the short run AS curve will shift rightward due to decrease in production cost

Equilibrium real gdp will rise

Price level will fall