b. How will output and inflation in both the short run and the long run be affec

Question

b. How will output and inflation in both the short run and the long run be affected if the effects of the tax cuts are stronger on long-run aggregate supply than on aggregate demand?

Both the Y* (potential output) and AD curves will shift to the left, so output will fall and inflation will be higher. The Y* (potential output) curve will shift to the right less than the AD curve, so output will increase and inflation will be higher. The Y* (potential output) curve will shift to the right more than the AD curve, so output will increase and inflation will be lower. The Y* (potential output) curve will shift to the right and the AD curve will shift to the left, so output will be the same and inflation will be lower.

Explanation / Answer

The Y* (potential output) curve will shift to the right less than the AD curve, so output will increase and inflation will be higher.

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