Aggregate supply, aggregate demand and fiscal policy


1. Assume the United States economy is operating below the full-employment level of output and the government has a balanced budget. 

a. Using a correctly labeled AD and AS graph, show how an increase in government spending will affect the following in the short run:

i. Real output

ii. The price level

Now assume that instead of increasing government spending, the US government decreases corporate-profits taxes.

b. Using a correctly labeled AD and AS graph, show and explain how this decrease in corporate-profits taxes will affect each of the following: 

i. Aggregate demand

ii. Long-run aggregate supply

iii. Real output

iv. Price level

c. Assume that the USA produces two goods, X and Y. Draw a production possibilities curve for this economy. Now show on the graph how this decrease in corporate-profits taxes will affect this economy’s production possibilities curve. (i.e., Will it shift? No shift? Movement along the curve? Etc.) 

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