In the long-run ISLM model and with everything else held constant,the long-run effect of a tax cut is to ________ real output and ________ the interest rate.
A)increase;increase
B)increase;not change
C)not change;increase
D)not change;decrease

Question

Quizplus · Accepted Answer

In the long-run, the IS curve is vertical and does not shift in response to changes in fiscal policy. Therefore, the tax cut will not change real output in the long-run. However, the LM curve will shift to the right in response to the increased demand for money due to the tax cut. This will cause a decrease in the interest rate in the long-run. Therefore, the correct answer is C, not change in real output and an increase in the interest rate.

In the Long-Run ISLM Model and with Everything Else Held