Y7

Problem 3: (25 points)

1. Explain how a decrease in tax rates in order to increase the aggregate demand and as a result a higher level of GDP can have a crowding out effect. (5 points)

2. Use the IS-LM model as well as the AD-AS model to explain the crowding out effect graphically. In your AD-AS model include both the very short-run AS and the positively sloped AS curves to differentiate between the resulted output levels. Use the same output level labels in both models to relate your two models to each other and get full credit. (20 points)