Answer to Question #48146 in Macroeconomics for Sarah

Question

1- If actual production is Y=$6 billion, describe how will the economy return to the goods market equilibrium?

2- The government has been running deficits for the past year and decides it must balance the budget, so it increases taxes to $1.2 billion, Explain how this changes the IS curve?

Answer 1

1. An increase in aggregate demand to AD2 boosts real GDP to Y2 and the price level to P2, creating an inflationary gap of Y2 − YP. In the long run, as price and nominal wages increase, the short-run aggregate supply curve moves to SRAS2. Real GDP returns to potential.
2. The last determinant of slope is the tax rate. An increase in the tax rate reduces the slope of the aggregate demand curve.The flatter aggregate demand curves produce an IS curve that is steeper as a result of the increase of the tax rate.