Using the AD-AS model show what will happen to the equilibrium level of output Y and...

Using the AD-AS model show what will happen to the equilibrium level of output Y and the level of prices P if

a. There is an increase in oil prices.

b. The government raises taxes.

c. There is an increase in oil prices and the government increases spending to fight a recession.

Solutions

Expert Solution

In the AD-AS model, when government increase taxes, then disposable income of the people decrease, so they consume less and therefore the consumption decreases. Since consumption is the part of the AD, so the AD will shifts leftward from AD to AD1. So equilibrium price decreases and real GDP also decreases to Y1.

When there is an increase in the oil prices and government increases spending to fight a recession, then AD increases because government expenditure increases and government expenditure is the part of the AD, so AD curve shifts rightward from AD to AD1 and AS curve shifts leftward from AS to AS1 due to decrease in the production due to increase in the oil prices.

Hence equilibrium price increases from P to P1 and real GDP may increase, decrease or remains same.

Rahul Sunny answered 1 month ago

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