On the graph above,suppose the economy is at point 1.Which sequence of points best illustrates the short-run and then long-run impacts if taxes are reduced for one year,then returned to the original level? [Assume that potential output remains constant at
.]

Question

On the graph above,suppose the economy is at point 1.Which sequence of points best illustrates the short-run and then long-run impacts if taxes are reduced for one year,then returned to the original level? [Assume that potential output remains constant at 
.]

Quizplus · Accepted Answer

If taxes are reduced for one year, the aggregate demand will shift to the right, and the economy will move from point 1 to point 2 in the short-run. However, in the long-run, prices will adjust to the new level of output, and the economy will return to its potential output at point 4. If taxes are then returned to their original level, the aggregate demand will shift to the left, and the economy will move from point 4 to point 1 in the short-run. Therefore, the sequence of points that best illustrates the short-run and long-run impacts of tax reduction and increase is 2, 4, and 1.

On the Graph Above,suppose the Economy Is at Point 1