Real Output 6. 1981-1984. The Reagan adminis- tration cut business and personal

Question

Real Output 6. 1981-1984. The Reagan adminis- tration cut business and personal income taxes. Defense spending rose, but most non-defense spend- ing fell. Price Level Real Output 7. 1991-1993. The Persian Gulf War caused a temporary increase in oil prices. Consumer confiden fell. Government spending in- creased only slightly during the war because most equipment came from existing inventories. European economies suffered severe recession and therefore purchased fewer U.S. goods. Price Level Real Output ©Keenan & Maier

Explanation / Answer

6. As this is in the (price, real output) space we will look at changes in aggregate demand and aggregate supply alone. As personal and income taxes fall this will mean that there will be changes to disposable income. Consumption will thus rise. Defense spending rose but most non defense spending fell. This will mean that government spending over all will fall. The AD curve will thus shift rightwards due to the change in consumption, partially stemmed by the overall fall in government spending. The AD curve will thus shift rightwards as taxes fall.

7. As there is an increase in oil prices the costs of production will rise and so the AS curve will shift leftwards causing a fall in output and a rise in prices.As government spending will fall overall and also consumer confidence falls this will mean that the AD curve will shift leftwards causing output levels to fall further. The degree of price increase will depend on the relative shifts of AD and AS.

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