Taxes paid by households and spending by same large amount

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Use the AD/AS model to diagram the following events, showing what will happen in the short run and in the long run. Unless otherwise instructed, assume that each economy starts from full employment. Also, state clearly what will happen to output and the price level in the short run and in the long run.

a) Starting from full employment, what will happen to an economy if the government increases both taxes paid by households and spending by the same large amount (according to AS/AD analysis)? Does this outcome seem realistic in a market economy?

b) We know that when an economy starts out at long-run equilibrium and the government cuts taxes, this will only result in inflation in the long run. What happens if the economy is producing a level of output below the full-employment (long-run equilibrium) level and the government cuts taxes?

Reference no: EM131162956

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