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

Question

Quizplus · Accepted Answer

A large tax increase is an example of an exogenous decrease in spending, which shifts aggregate demand left, decreases the short-run equilibrium, and causes a recessionary gap. As a result, inflation will gradually decrease, thereby shifting the SRAS line downward. When inflation has fallen enough, the economy is back in long-run equilibrium at potential output.

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