Answer to Question #97656 in Macroeconomics for Tiffany

Question

3. Everyone loves a tax cut. How will the short-run effects of a tax cut on the price level and on unemployment differ if the economy is in a recession from the effects if the economy is at full employment? (Hint: Examine the slope of the AS curve.)

Answer 1

The horizontal section of the curve corresponds to the AS downturn economy, high unemployment and under-utilization of production capacity. In these circumstances, tax reduction is desirable because it leads to an increase in production and employment without increasing the overall level of prices.

A vertical segment of the AS curve occurs when the economy is operating at full capacity and it is no longer possible to achieve further growth in production in a short time. An increase in aggregate demand due to a reduction in taxes under these conditions will lead to an increase in the general price level. And the increased prices do not tend to decrease in the short term and will remain at the same level.