Use the AD-AS diagram to graphically illustrate the short-run and long run impacts of an increase...

Use the AD-AS diagram to graphically illustrate the short-run and long run impacts of an increase in taxes on the price level and income. Write down the impact of this policy on income, interest rate, unemployment and investment.

Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run and long-run equilibriums.

Solutions

Expert Solution

Ans.

In short run:

Due to increase in the taxes, AD curve will shift to the left as people will now spend less due to tax.

Due to shift in the AD to the left, Price and income will fall.

Due to increase in taxes, IS curve will also shift to the left, causing interest rate to decrease.

Investment has ambiguous effect, bcoz due to decrease in interest rate investment will increase, but due to income tax increase investment will fall.

And now as demand is fall, output is fall, unemployment will also increase.

In long run-

As prices fall due to income tax, this fall in price leads to increase in real money supply ( M/P)

Due to this increase AD curve will shift to the rightwards, back to the initial equilibrium point.

Price and income will increase, employment increase.

Now, LM curve will shift to the right, causing decrease in the interest rate, and increase in imcome.

Rahul Sunny answered 1 year ago

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