Final Exam Macroeconomics

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Chapter 8 9 10 11 12 13 14

Buying side of demand

Aggregate Demand

Producing side of aggregate supply

Aggregate Supply. SRAS: production in the short run LRAS: production in the long run

Aggregate Demand

The quantity demanded of all goods and service (Real GDP) at different price levels, ceteris paribus.

Aggregate Demand Curve

A curve that shows the quantity demanded of all goods and services (Real GDP) at different proce levels, Ceteris paribus. Downward sloping curve indicated an inverse relationship between price level and the quantity demanded of Real GDP

Why does the Aggregate Demand curve curve slope downward?

The Real Balance Effecr
Interest Rate Effect
International Trade Effect

Real Balance Effect

The change in the purchasing power of dollar denominated assets that results from a change in the price level.
When price level falls, purchasing power rises, monetary wealth rises and more goods are bought.
When price level rises, purchasing power falls, monetary wealth falls and less goods are bought.

Interest Rate Effect

Changes in household and business buying as the interest rate changes.
Price level falls, purchasing power rises, less money needed to buy fixed bundle of goods, save more, supply of credit rises, interest rate falls, businesses and households borrow more at lower interest rate, and more goods are bought.

International Trade Effect

The change in foreign sector spending as the price level changes.
Price level in U.S. falls relative to foreign price levels, U.S. goods relatively less expensive than foreign goods, both Americans and foreigners buy more U.S. goods.

A change in quantity demanded

A change in quantity demanded of Real GDP is the result of a change in the price level. Movement along the AD curve.

Change in Aggregate Demand

Shift of the Aggregate Demand Curve. It is caused by a change in spending.

Consumption Factors that change Aggregate Demand

Wealth, Expectation of Future Prices, Expectations of Future Income, Interest Rates, Income Taxes

Wealth

Wealth rises, Consumption rises, AD rises
Wealth falls, Consumption falls, AD falls

Expectation of Future Prices

Expect higher prices, consumption rises, AD rises
Expect lower prices, consumption falls, AD falls

Expectation of Future Income

Expect higher income, consumption rises, AD rises
Expect lower income, consumption falls, AD falls

Interest Rate

Interest rate rises, consumption falls, AD falls
Interest rate falls, consumption rises, AD rises

Income Taxes

Income taxes rise, consumption falls, AD falls
Income taxes fall, consumption rises, AD rises

Investment Factors that change Aggregate Demand

Interest rate, optimism/ pessimism about future sales, Business taxes

Interest rate (investment)

Interest rate rises, Investment falls, AD falls
Interest rate falls, Investment rises, AD rises

Future sales

Optimistic future sales, Investment rises, AD rises
Pessimistic future sales, Investment falls, AD falls

Business taxes

Business taxes fall, Investment rises, AD rises
Business taxes rise, Investment falls, AD falls

Net Export Factors that change Aggregate Demand

Foreign Real National Income, Exchange rate

Foreign Real National Income

Foreign real national income rises, exports rise, net export rises, AD rises
Foreign real national income falls, exports fall, net exports fall, AD falls

Exchange Rate

US $ depreciates, exports rise, imports fall, net exports rises, AD rises
US $ appreciates, exports falls, imports rise, net exports fall, AD falls

Explain the real balance effect.

A rise in the price level causes purchasing power to fall, which decreases a person's monetary wealth. As people become less wealthy, the quantity demanded of Real GDP falls.

Explain what happens to the AD curve if the dollar appreciates relative to other currencies.

If the dollar appreciates, it takes more foreign currency to buy a dollar and fewer dollars to buy foreign currency. This makes U.S. goods more expensive for foreigners and foreign goods cheaper for Americans. In turn, foreigners buy fewer U.S. exports, and Americans buy more foreign imports. As exports fall and imports rise, net exports fall. If net exports fall, total expenditures fall,. As total expenditures fall, the AD curve shifts to the left.

Aggregate Supply

The quantity supplied of all goods and services at different price levels. The SRAS curve is sloping upwards specifying a direct relationship between price level and the quantity supplied of Real GDP.

Why does the Aggregate Supply curve slope upward?

Sticky wages and worker misconceptions

Sticky Wage, the Real Wage Rate and SRAS

labor contracts. While firms pay nominal wages, they often decide how many worker to hire based on real wages.

Real Wage Equation

Nominal Wage/ Price Level

Real Wages change on Aggregate Supply (workers)

Price level rises, Real Wage falls, QS of labor rise
Price level falls, Real wage rises, QS of labor rise

Real Wages change on Aggregate Supply (firms)

Firms will employ more workers when it's cheaper to hire them.
Real wage rises, QD of labor demanded falls
Real wage falls, QD of labor demanded rises
An increase in price (which pushes real wages down) will result in an increase in output. Thus upward sloping.

Worker Misconceptions

If workers misperceive real wage changes, then a fall in the price level will bring about a decline in output. In response to the misperceive falling real wage, workers may reduce the quantity of labor they are willing to supply. With less producer, produce less goods

Changes in Aggregate Supply that shift supply

Wage rates, prices of non-labor inputs, productivity, supply shocks (adverse, beneficial)

Changes in Wage Rates

Profit per unit= Price per unit - Cost per unit
Higher wage rates mean higher costs and, at constant prices, translate into lower profits and a reduction in the number of units firms will want to produce.
Lower wage rates mean lower costs and, at constant prices, translate into higher profits and an increase in the number of units firm will decide to produce.

Changes in the Price of Non-Labor Inputs

Changes in the prices of non-labor inputs affect the SRAS curve in the same way as changes in wage rates do. An increase in the price of a non-labor input shifts the SRAS curve leftward

Changes in Productivity

I.e. More educated labor force, a larger stock of capital goods, technological advancements
An increase in labor productivity means business will produce more output with the same amount of labor, causing the SRAS curve to shift righrtward.
A decrease in labor productivity means businesses will produce less output with the same amount of labor, causing the SRAS curve to shift leftward.

Supply Shocks

Major natural or institutional changes that affect aggregate supply
Adverse supply socks shift the SRAS curve leftward
Beneficial supply shocks shift the SRAS curve rightward

If wage rates decline, explain what happens to the short-run aggregate supply (SRAS) curve.

AS wage rates decline, the cost per unit of production falls. In the short run, profit per unit rises. Higher profit causes producers to produce more units pf their goods and services. The SRAS curve shift right.

Give an example of an increase in labor productivity.

Ten workers produced 100 units of good X in 1 hour. This year, 10 workers produced 120 units of good X in 1 hours.

Discuss the details of the worker misperceptions explanation for the upward-sloping SRAS curve.

Workers initially misperceive the change in their real wage due to a change in the price level. If a nominal wage is $30 and the price level is 1.50 the real wage is $20. If the nominal wage falls to $25 and the price level falls to 1.10, the real wage is now $22.72. If they misperceive the price level to be 1.4, they believe the real wage is falling when it actually increasing. As such, QS decreases

Short Run Equilibrium

Where the quantity demanded of Real GDP equals the short-run quantity supplied.

Long Run Aggregate Supply

LTAS curve is a vertical line at the level of Natural Real GDP. It represents the output the economy produces when all economy wide adjustment have taken place and workers do not have any relevant misperceptions.

Short Run Equilibrium

QD of Real GDP = Short Run QS of Real GDP
Aggregate Demand curve intersects the short-run aggregate supply curve.

Long Run Equilibrium

When wages and prices have adjusted to their final equilibrium levels and workers do not have any relevant misconceptions. LRAS and AD curve intersect at this point.

Disequilibrium

The state of the economy as it moves from short run equilibrium to long run equilibrium. The QS and the QD of Real GDP are not equal.

What is the difference between short-run equilibrium and long-run equilibrium?

In long-run equilibrium, the economy is producing Natural Real GDP. In short-run equilibrium, the economy is not producing Natural Real GDP, although the quantity demanded of Real GDP equals the quantity supplied of Real GDP

Say's Law

Supply creates its own demand. Production creates demand sufficient to purchase all goods and services produced.

Say's Law implies that there cannot be either

A general overproduction of goods (where supply in the economy is greater than demand in the economy
A general underproduction of goods

Say's Law in a barter economy

A baker's act of supplying bread is linked to his dmenad for other goods. Supply creates its own demand.
If supplying some goods lead to a simultaneous demand for other goods, then Say's law implies that there cannot be wither a overproduction or underproduction of goods.

Say's Law in a Money Economu

Consumption falls and saving rises, economic forces are at work producing an equal increase to investment.

Saving Increase- Say's Law

Saving increases, interest rates decrease, amount of investment increases.

Classical View of the Credit Market

The interest rate is flexible and adjusts so that saving equals investment. Saving curve shifts rightward and puts pressure on the interest rate that moves downward. New equilibrium is established where once again the amount households save equals the amount firms invest

Explain Say's law in terms of a barter economy.

The act of supplying is motivated by the desire to demand. Supply and demand are opposite sides of the same coin.

According to classical economists, if saving rises and consumption spending falls, will total spending in the economy decrease? Explain your answer.

No, total spending will not decrease. For classical economists, an increase in saving (reflected in a decrease in consumption) will lower the interest rate and stimulate investment spending

What is the classical position on prices and wages?

Prices and wages are flexible; they move up and down in response to market conditions

Three States of the Economy

Recessionary gap, inflationary gap, long-run equilibrium)

Recessionary Gap

Real GDP < Natural Real GDP
Unemployment Rate > Natural Unemployment Rate

Inflationary Gap

Real GDP > Natural Real GDP
Unemployment Rate < Natural Unemployment Rate

Long Run Equilibrium

Real GDP= Natural Real GDP
Unemployment rate= Natural unemployment rate

Physical PPF

Illustrate different combinations of goods in the economy can produce given the physical constraints of finite resources and the current state of technology. If the economy is operating at point between the institutional and physical PPF then the unemployment rate is less than the natural unemployment rate

Institutional PPF

Illustrate different combinations of goods in the economy can produce given the physical constraints of finite resources, the current state of technology and any institutional constraints. The economy is at the natural unemployment rate

What is the state of the labor market when the economy is in a recessionary gap? in an inflationary gap?

When the economy is in a recessionary gap, the labor market has a surplus. When the economy is in an inflationary gap, there is a shortage in the labor market.

If the economy is in an inflationary gap, locate its position in terms of the two PPFs discussed in this section.

The economy is somewhere above the institutional PPF and below the physical PPF.

Closing the Recessionary Gap

Wages rates fall, the SRAS curve shifts rightward. Price level falls, the real balance, interest rate and international trade effects increase the QD of Real GDP. Economy moves to long-run equilibrium.

Closing the Inflationary Gap

Wage rates rise, the SRAS curve shifts leftward. AS the price level rises, the real balance, interest rate and international trade effects decrease QD of Real GDP. The economy moves into long-run equilibrium.

Laissez- faire

The economy is self-regulating. Full employment is the norm: The economy always moves back to Natural Real GDP. Laissez-faire: A public policy of not interfering with market activities in the economy.

Economic growth

Economic growth macroeconomics deals with rightward shifts in the long-run aggregate supply curve.

If the economy is self-regulating, what happens if it is in a recessionary gap?

In a recessionary gap, the existing unemployment rate is greater than the natural unemployment rate, implying that unemployment is relatively high. As wage contracts expire, business firms will negotiate new ones that pay workers lower wage rates. As a result, the SRAS curve shifts rightward. As this happens, the price level begins to fall. The economy moves down the AD curve—eventually to the point where it intersects the LRAS curve. At this point, the economy is in long-run equilibrium.

If the economy is self-regulating, what happens if it is in an inflationary gap?

In an inflationary gap, the existing unemployment rate is less than the natural unemployment rate, implying that unemployment is relatively low. As wage contracts expire, business firms will negotiate contracts that pay workers higher wage rates. As a result, the SRAS curve shifts leftward. As this happens, the price level begins to rise. The economy moves up the AD curve—eventually to the point where it intersects the LRAS curve. At this point, the economy is in long-run equilibrium.

If the economy is self-regulating, how do changes in aggregate demand affect the economy in the long run?

Any changes in aggregate demand will affect—in the long run—only the price level, not the Real GDP level or the unemployment rate. Stated differently, changes in AD in an economy will have no long-run effect on the Real GDP that a country produces or on its unemployment rate; changes in AD will change only the price level in the long run.

Keynesian Challenged Say's Law of

1. Insufficient demand in the economy is unlikely.
2. Wages, price, and interest rates are flexible.
3. The economy is self-regulating.
4. Laissez-faire is the right and sensible economic policy.

Keynes's View of Say's Law in a Money Economy

A decrease in consumption and subsequent increase in saving may not be matched by an equal increase in investment. Thus, a decrease in total expenditures may occur.

Keynes on Savings and Investment

Saving is more responsive to changes in income than to changes in the interest rate and that investment is more responsive to technological changes, business expectations, and innovations than to changes in the interest rate.

Keynes on Wages

The labor market may adjust slowly. In particular, a lowered demand for labor may not be met with a declining wage rate. Wage rates might be inflexible downward. If wage rates are inflexible downward, then the self-regulating properties of an economy are in question. Specifically, an economy might get stuck in a recessionary gap.

Keynes on Prices

Keynes said that the internal structure of an economy is not always competitive enough to allow prices to fall. Keynes suggested that anticompetitive or monopolistic elements in the economy sometimes prevent price from falling.

What do Keynesians mean when they say the economy is inherently unstable?

Keynesians mean that an economy may not self-regulate at Natural Real GDP. Instead, an economy can get stuck in a recessionary gap.

According to Keynes, why might aggregate demand be too low?

The main reason is that Say's law may not hold in a money economy. The question is why doesn't Say's law hold in a money economy? Keynes argued that an increase in saving (which leads to a decline in demand) does not necessarily bring about an equal amount of additional investment (which would lead to an increase in demand), because neither saving nor investment is exclusively affected by changes in the interest rate

Simple Keynesian Model

The price level is assumed to be constant until the economy reaches its full-employment or Natural Real GDP level.
There is no foreign sector. The model represents a closed economy, not an open economy. It follows that total spending in the economy is the sum of consumption, investment, and government purchases.
Monetary side of the economy is excluded

Consumption Function

The relationship between consumption and disposable income. Consumption is directly related to disposable income and is positive even at zero disposable income.

Consumption Function Equation

C= C0+ (MPC) (Yd)

C0

autonomous consumption- The part of consumption that is independent of disposable income.

MPC

Marginal propensity to consume- The ratio od the change in consumption to the change in disposable income: MPC= Change in C/ Change in Yd.

Yd

Disposable income- Income received less taxes

Consumption Function

1. Consumption depends on disposable income
2. Consumption and disposable income move in the same direction
3. When disposable income changes, consumption changes by less (MPC)

Saving

Disposable Income less Consumption.

MPS

Marginal propensity to save (MPS) is the ratio of the change in saving to the change in disposable income

Multiplier

The number that is multiplied by the change in autonomous spending to obtain the overall change in total spending.
The multiplier is equal to 1/(1-MPC0.
If the economy is operating below Natural Real GDP, then the multiplier by the change in autonomous spending to obtain the change in Real GDP.

Change in Total Spending Equation

Change in total spending= Multiplier x Change in autonomous spending

The Multiplier and Aggregate Demand

An initial increase in autonomous consumption raides total spending and shifts the aggregate demand curve rightward. Because of the multiplier, the increase in autonomous spending generates additional incomes and additional spending, shifting the aggregate demand curve farther rightward.

How is autonomous consumption different from consumption/

Autonomous consumption is one of the components of overall consumption.

If the MPC= .70, what does the multiplier equal?

1/(1-0.70) 3.33

What happens to the multiplier as the MPC falls?

The multiplier falls.

Keynesian Aggregate Supply curve

The AS curve in the simple Keynesian model is horizontal until QN (Natural Real GDP) and vertical at QN. Any change in aggregate demand in the horizontal section fo not change the price level, but any changes in aggregate demand in the vertical section do change the price level.

Can the Private Sector Remove the Economy from a Recessionary gap?

Increasing spending to shift the AD curve rightward and create equilibrium sometimes could not happen. No matter how low interest rates fell, investment spending would not rise because of pessimistic business expectations with respect to future sales.

Simple Keynesian Model I

The price level is constant until Natural GDP is reached.
The AD curve shifts if there are changes in C, I or G
According to Keynes, it is possible for the economy to be in equilibrium and in a recessionary gap too.

SImple Keynesian Model II

The private sector may not be able to get the economy out of a recessionary gap, meaning not able to increase C or I enough to get the AD curve in to intersect the AS curve at the Natural Level of Real GDP. The government may have a management role to play in the economy. It to its Natural Real GDP level.

What was Keynes's position with respect to the self-regulating properties of an economy?

Keynes believed that the economy may not always self regulate itself at Natural Real GDP. The private sector of the economy are not always capable of generating enough AD in the economy so that the economy equilibrates at Natural Real GDP.

What will happen to real GDP if autonomous spending rises and the economy is operating at the horizontal section of Keynesian AS curve? Explain your answer.

The increase in autonomous spending will lead to a greater increase in total spending and to a shift rightward in the AD curve. If the economy is operating in the horizontal section of the Keynesian AS curve,
Real GDP will rise, and there will be no change in prices

An economist who believes the economy is self-regulating is more likely to advocate laissez- faire than an economist who believes the economy is inherently unstable. Do you agree or disagree? Explain your answer.

Agree, The economist who believes the economy is inherently unstable sees a role for government. Governement is supposed to stabilize the economy at Natural Real GDP. The economist who beleives the economy is self-regulating (capable of moving itself to Natural Real GDP) sees onlu a small, if any, role for government because the economy is already doing the job government would supposedly do.

Total Expenditures Curve

At different levels of Real GDP, we sum consumption, investment, and government purchases to derive TE curve.

Total Production Curve

45-degree line (it bisects the 90-degree ange at the origin). At any point on the TP curve, total production is equal to Real GDP. TP and GDP are different names for the same thing.

Three States of the Economy in the TE-TP Framework

At Qe, TE= TP and the economy is in equilibrium.
TE<TP
TE>TP

TE< TP

results in an unexpected increase in inventories, which signals firms that they have overproduced, which leads firm to cut back on production
The cutback in production reduces Real GDP. The economy moves to equilibrium

TE > TP

This results in an unexpected decrease in inventories which signals firms that they have underproduced, which lead firms to raise production. Increased production raises Real GDP and the economy moves into equilibrium

TE= TP

The economy is in equilibrium, however the Natural Real GDP is great than QE, so the economy is in a recessionary gap as well as being in equilibrium

Keynesian Model in terms of TE/ TP

1. The price level is constant until Natural Real GDP is reached.
2. The TE curve shifts if there are chanfes in C, I, or G.
3. It is possible for the economy to be in equilibrium and in a recessionary gap too.
4. The private sector may not be able to get the economy out of a recessionary gap.
5. The governement may have a mangement role in to play in the economy. Government may have to raise TE enough to stimulate the economy out of the recessionary gap and move it to its Natural Real GDP level.

What happens in the economy if total production (TP ) is greater than total expenditures (TE )?

When TP is greater than TE, firms are producing and offering for sale more units of goods and services than households and governments want to buy. As a result, business inventories rise above optimal levels. In reaction, firms cut back on their production of goods and services. This leads to a decline in Real GDP, which stops falling when TP equals TE.

What happens in the economy if total expenditures (TE ) are greater than total production (TP )?

When TE is greater than TP, households and businesses want to buy more than firms are producing and offering for sale. AS a result, business inventories fall below optimal levels. In reaction, firms increase their production of goods and services. This leads to a rise in Real GDP, which stops rising when TP equals TE.

3 Income Taxe structures

Progressive income tax, proportional income tax, regressive income tax

Progressive income tax

An income tax system in which one's tax rate rises as taxable income rises.

Proportional income tax

An income tax system in which a person's tax rate is the same regardless of taxable income

Regressive income tax

An income tax system in which a person's tax rate declines as his or her taxable income rises.

Marginal Tax Rate

The change in a person's tax payment divided by the change in his or her taxable income.

Budget Deficit

Government expenditures greater than tax revenues

Budget surplus

Tax revenues greater than government expenditures

Balanced budget

Government expenditure equal to tax revenues

Structural Deficit

The part of the budget deficit that would exist even if the economy were operating at full employment

Cyclical Deficit

The part of the budget deficit that is a result of a downturn in economic activity

Public debt

The total amount the federal government owes to its creditors

Value Added tax

Value added is the difference between what a producer sells a final good for and what it pays for an intermediate good. VAT is a tax applied to the value added at each stage of production. VAT generates tax revenue and raises prices. The VAT is nothing more than a less visible sales tax.

What three taxes account for the bulk of federal tax revenues?

Individual income tax, corporate income tax, and Social Security taxes.

Fiscal Policy

Changes in government expenditures and/or taxes to achieve particular economic goals, such as low unemployment, stable prices, and economic growth

Expansionary fiscal policy

Increase in government expenditures and/or decrease in taxes to achieve particular economic goals

Contractionary Fiscal Policy

Decreases in government expenditures and/or increases in taxes to achieve particular economic goals.

Discretionary Fiscal Policy

Deliberate changes of government expenditures and/or taxes to achieve particular economic goals

Automatic Fiscal Policy

Changes in government expenditures and/or taxes that occur automatically without additional congressional action.

Demand Side Fiscal Policy

A change in C, I, G, and NX can change aggregate demand and therefore shift the AD curve.

Demand Side Fiscal Policy- Decrease in government spending

Decreases aggregate demand and shifts the AD curve to the left.

Demand Side Fiscal Policy- Increase in government spending

Increases Aggregate demand and shifts the AD curve to the right.

Demand Side Fiscal Policy- Decrease in taxes

Increases aggregate demand and shifts the AD curve to the right.

Demand Side Fiscal Policy- Increase in taxes

Decreases aggregate demand and shifts the AD curve to the let

Expansionary Fiscal Policy- Recessionary gap

Increased government purchases, decreased taxes, or both lead to a rightward shift in the aggregate demand curve restoring the economy to the natural level of Real GDP.

Contrationary Fiscal Policy

Decreased government purchases, increased taxes, or both lead to a leftward shift in the aggregate demand curve restoring the economy to the natural level of Real GDP.

Crowding Out

The decrease in private expenditures that occurs as a consequence of increased government spending (direct effect) or the financing needs of the Federal budget deficit

Complete Crowding Out

A decrease in one or more components of private spending completely offsets the increase in government spending.

Incomplete crowding out

The decrease in one or more components of private spending only partially offsets the increase in government spending.

Zero Crowding Out

Private spending remains constant. AD increases. Real GDP increases. Unemployment rate decreases.

Data Lag

Policymakers are not aware of changes in the economy as soon as they happen

Wait- and -see lag

After policymakers are are of a downturn in economic activity they rarely enact counteractive measures immediately. They want to be sure that the observed events are not just short-run.

Legislative lag

After policymakers decide that some type of fiscal policy measure is required, Congress or the president will have to propose the measure, build political support for it, and get it passed.

Transmission Lag

After enacted, a fiscal policy measure takes time to be put into effect.

Effectiveness lag

After a policy measure is actually implemented, it takes time to affect the economy.

Fiscal Policy may destabilize the economy

STAS is shifting rightward, healing the recessionary gap, but this information is unknown to policymakers. Policymakers implement expansionary fiscal policy, and the AS curve ends up intersecting SRAS2 instead of SRAS1 (point of equilibrium). Policymakers thereby move the economy into an inflationary gap, destabilizing the economy.

How does crowding out question the effectiveness of expansionary demand-side fiscal policy?

If there is no crowding out, expansionary fiscal policy is predicted to increase aggregate demand and, if the economy is in a recessionary gap, either reduce or eliminate the gap.
However, if there is, say, complete crowding out, expansionary fiscal policy will not meet its objective. The following example illustrates complete crowding out: If government purchases rise by $100 million, private spending will decrease by $100 million so that there is no net effect on aggregate demand.

How might lags reduce the effectiveness of fiscal policy?

Suppose the economy is currently in a recessionary gap at time period 1. Expansionary fiscal policy is needed to remove the economy from its recessionary gap, but fiscal policy lags (data lag, wait-and-see lag, etc.) may be so long that, by the time the fiscal policy is implemented, the economy has moved itself out of the recessionary gap, making the expansionary fiscal policy not only unnecessary but potentially capable of moving the economy into an inflationary gap.

Give an example of the indirect effect of crowding out.

The federal government spends more on a given program. As a result, the budget deficit grows, and the federal government increases its demand for loanable funds (or credit) to finance the larger deficit. Because of the greater demand for loanable funds, the interest rate rises in response to the higher interest rate, and business firms cut back on investment. An increase in government spending has indirectly led to a decline in investment spending.

Supply- Side Fiscal Policy

A cut in marginal tax rates increases the atractiveness of productive activity relative to leisure and tax avoidance activities. Shifts resources from the latter to the former, thus shifting both the short run and long run aggregate supply curves rightwards.

Laffer Curve

Shows the relationship between tax rates and tax revenues. AS tax rates rise from zero, tax revenues rise, reach a maximum at some ount and then fall with further increases in rate rates.

Tax Revenues

Tax base x Average tax rate.
If the % reduction in the rax rate is greater than the % increase in the tax base, tax revenues decrease
If the % reduction in the tax rate is less than the % increase in the tax base, tax revenues increase.

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