Question

Assume you put two policies in place, a tax on carbon emissions and a tax on gas at the same time. How would you illustrate these most crucial policy decisions using the Aggregate Demand and Aggregate Supply Model? How will the Price Level, Real GDP, and Employment be impacted in the short-run if these most critical policy decisions are put into practice at the same time? How might the Price Level, Real GDP, and Employment be impacted in the long-run if these most important policy decisions are put into practice at the same time? Be detailed, specific, and precise.

Answer 1

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Carbon tax and gas tax will reduce consumption level. Both of these factors leads to fall in aggregate demand in short run which shift demand curve to its left in short run from AD to AD1 while keep supply curve same.

It will reduce price level from P to P1 and reduce output level from Y to Y1 which will result in rise in unemployment in short run.

Reduced aggregate demand in short run will induce producers to reduce their quantity supplied in long run to avoid inventories which will shift supply curve to its left from AS to AS1. It result in rise in price to its initial level of P and reduce output further to Y2 which raise unemployment level.