Based on the figure below. 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

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

Based on the Figure Below