Using the aggregate demand-aggregate supply model, predict what happens in the short run when the federal government enacts a cut in the personal income tax rates.

1) The aggregate supply curve shifts right; the aggregate demand curve is not affected; price level decreases; real GDP increases.

2) The aggregate supply curve shifts left; the aggregate demand curve is not affected; price level increases; real GDP decreases.

3) The aggregate demand curve shifts right; the aggregate supply curve is not affected; price level and real GDP increase.

4) The aggregate demand curve shifts left; the aggregate supply curve is not affected; price level and real GDP decrease.

Solutions

Expert Solution

If the federal government enacts a cut in the personal income tax rates, people's disposable income will increase. This will increase the Consumption spending. Increase in Consumption increases aggregate demand, shifting the AD curve rightward. However, the aggregate supply curve will remain unchanged. As a result, both equilibrium price level and real GDP increase.

Answer: option 3

Rahul Sunny answered 1 year ago

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