Question

Describe and explain the short-run and long-run effects of an increase in taxes on a closed economy in the short run.

1. What is the effect of an exogenous increase in investment in the Aggregate Demand/Aggregate Supply (AD/AS) diagram?

2. Consumption

3. Real GDP

4. Price level

5. Unemployment

6. Interest rate

7. Investment

Answer 1

The increase in tax rates will lead to
the decreased AD in the
economy. Hence as a result the
AD will shift leftward.
As a result of the increased tax rates, there will be lesser disposable
money with people, hence
their consumption will drop.
The leftward shift of AD will
lead to the fall in the price level
and real GDP causing the
creation of recessinary gap in
the economy.
At this level, the level of
unemployment rises as the
economy is performing under
the potential level of output.
The intetest rates fall in the
economy .Investment
also fall because people have lesser money, hence
investments decrease.

But in the long run , the consumption and investment will rise due to lesser interest rates. Hence AD will recover back to its original.