The AD-AS model in the diagram below shows that,at the initial short-run equilibrium point B,the economy is experiencing ___________ gap.Starting from point B,an income tax cut that shifts the aggregate demand curve from AD to AD' will lead to a new short-run equilibrium at point ___________.In this case,the tax cut,instead of eliminating the initial recessionary gap has,in fact,created ___________ gap.The tax authorities,in this case,have __________ the size of the initial output gap.

Question

Quizplus · Accepted Answer

At the initial short-run equilibrium point B, the economy is experiencing a recessionary gap as the actual output Y is less than the potential output Y*. A tax cut that shifts the aggregate demand curve to AD' will lead to a new short-run equilibrium at point D, where the output level increases, but it is still less than the potential output Y*. Therefore, the tax cut has created an expansionary gap, which is the distance between the actual output level at point D and the potential output. The tax authorities have overestimated the size of the initial output gap as their policy has not eliminated the recessionary gap.

The AD-AS Model in the Diagram Below Shows That,at the Initial