Question

Assume the economy is initially operating at the natural level of output, and suppose a budget is passed that calls for a tax cut This fiscal expansion will, in the short run, cause an increase in:

A) The interest rate

B) The nominal wage

C) The output level

D) All of the above

Answer 1

A tax cut will increase the spending level in an economy as a result, the aggregate demand curve shifts rightward which leads to increase in output and price level. An increase in price level leads to increase in nominal wage.

Due to increase in output, the money demand increases. An increase in money demand leads to rightward shift of the money demand curve, since money supply remains constant. Rightward shift of the money demand leads to increase in interest rate.

Answer: Option (D) i.e., all of the above.