Supply-side effects

Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows the aggregate demand (AD) curve and short-run aggregate supply (AS) curve for the economy. The long-run aggregate supply curve is represented by a vertical line at the potential GDP level of $6 trillion. The economy is initially producing at potential GDP.

Suppose that fiscal authorities decide to decrease marginal tax rates. Assume that this change in marginal tax rates is perceived as a long-term change.

Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on output and the price level.

Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther.

Homework: Managing Aggregate Demand: Fiscal Policy Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve ar to its original position, just drag it a little farther. 120 Potential GDP O 100 AS AD 80 AS 60 PRICE LEVEL Potential GDP 40 AD 20 6 8 10 12 QUANTITY OF OUTPUT (Trillions of dollars)