Refer to the accompanying figure. Starting from long-run equilibrium at point C, a tax increase that decreases aggregate demand from AD¹ to AD 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; C
D)A; B

Question

Refer to the accompanying figure.  Starting from long-run equilibrium at point C, a tax increase that decreases aggregate demand from AD¹ to AD 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; C 
D)A; B

Quizplus · Accepted Answer

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

Refer to the Accompanying Figure