Use the following to answer questions: -(Figure: Fiscal Policy II) Refer to Figure: Fiscal Policy II. Suppose that this economy is in equilibrium at E₁. If there is an increase in taxes, _____ will shift to the _____, causing a(n) _____ in the price level and a(n) _____ in real GDP. A) AD_1; left; increase; decrease B) AD_1; left; decrease; decrease C) AD_2; right; increase; increase D) AD_2; right; decrease; increase

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An increase in taxes will decrease consumption and investment, thus decreasing aggregate demand. This will shift the AD curve leftward, causing a decrease in both the price level and real GDP. The new equilibrium will be at a lower price level (S1U1B10) and a lower level of real GDP (Y1). Choice B is the only one that correctly identifies this shift and its effects on the economy.

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