Refer to the accompanying figure. Starting from long-run equilibrium at point C, a tax cut that increases aggregate demand from AD to AD¹ will lead to a short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________, if left to self-correcting tendencies.
A)D; B
B)D; C
C)B; A
D)B; C

Question

Refer to the accompanying figure.  Starting from long-run equilibrium at point C, a tax cut that increases aggregate demand from AD to AD¹ will lead to a short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________, if left to self-correcting tendencies.
A)D; B 
B)D; C 
C)B; A 
D)B; C

Quizplus · Accepted Answer

A tax cut is an example of an exogenous increase in spending, which shifts aggregate demand right. A new short-run equilibrium will exist at point D where the economy is experiencing 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 point B.

Refer to the Accompanying Figure