Based on the figure below. 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

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 - shifting the SRAS line upward. When inflation has risen enough, the economy is back in long-run equilibrium at point B.

Based on the Figure Below