Use the AD-AS model to explain the short-run and long-run effects on inflation (

Question

Use the AD-AS model to explain the short-run and long-run effects on inflation (), output (Y), the real interest rate (r), consumption (C), investment (I), and net exports (NX) of the following, include both diagrams and a written explanation:

a. a permanent increase in taxes ((bar) T rises)

b. the Federal Reserve tightens monetary policy ((bar) r rises)

c. there is a temporary (one-time) increase in autonomous investment ((bar) I increases one-time and then falls back to its original level)

Include in each of your answers, a box with what happens to each variable in period one and in the long run. Compare the period 1 results to the initial values of the variables and the long-run results to the initial values of the variables.

Change in                             Period one (short-run)                        Long-run (back to long-run equilibrium)

Inflation

Real output

Real interest rate

Consumption

Investment

Net Exports

Inflation

Real output

Real interest rate

Consumption

Investment

Net Exports

Explanation / Answer

a)When there is rise in taxes:

b) r bar rises:

c) Temporary increase in autonomous investment:

Change in equilibrium Short Run Long Run Inflation remains same falls Real Output falls falls Real interest Rate rremains same rises Consumption remains same falls Investment rises rises Net Exports falls falls

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