Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a temporary five-period tax increase causes output to _____ until returning to the natural level in the long run.
A) remain continuously above the natural level of output
B) move above and then below the natural level of output
C) remain continuously below the natural level of output
D) move below and then above the natural level of output.

Question

Quizplus · Accepted Answer

A temporary tax increase reduces aggregate demand, causing output to fall below the natural level initially. As the tax increase is temporary, expectations adjust, and output eventually returns to the natural level, moving above it before stabilizing.

Starting from Long-Run Equilibrium in the Dynamic Model of Aggregate