Starting from long-run equilibrium, a large tax cut will result in a(n)________ gap in the short-run and ________ inflation and ________ output in the long-run.
A)expansionary; higher; potential
B)expansionary; higher; higher
C)recessionary; lower; lower
D)recessionary; higher; potential

Question

Quizplus · Accepted Answer

A large tax cut is an example of an exogenous increase in spending, which shifts aggregate demand right, increases the short-run equilibrium, and causes an expansionary gap. As a result, inflation will gradually increase, thereby shifting the SRAS line upward. When inflation has risen enough, the economy is back in long-run equilibrium at potential output.

Starting from Long-Run Equilibrium, a Large Tax Cut Will Result