IS-MP-AD-IA model

to help the U.S. economy, the president argued that Congress pass a substantial payroll tax cut (which would reduce the amount of taxes being taken out of workers' paychecks). Assuming the economy starts out at potential output.

a) According to the IS-MP model, what would happen to output and the real interest rate in the short run? Draw a diagram to help explain your answer.

b) What would happen to the AD and IA curves in the short run? Draw a diagram to help explain your answer. What happens to output and inflation in the short run?

c) According to the IS-MP-AD-IA model, what should happen to output and inflation over time? Draw a diagram to help explain your answer.

d) If the tax cuts are permanent, what would be the long-run effect of the tax cut in the ADIA and IS-MP diagrams? Draw those diagrams to explain your answer.

e) What would be the long-run effect of the shock on output, inflation, and the real interest rate? What would be the long-run effect on consumption, investment, and government purchases? Briefly explain why.

f) Suppose that the economy starts out below potential output instead of at potential output. Moreover, suppose that after the tax cut, the economy is still below potential output in the short run. What are the main benefits of the tax cut in this case?