Question

Starting from a long run steady state equilibrium, significant increase in individual income taxes was announced. In the long run after market adjustments the economy will

A. experience a small deflation but aggregate output returns to the potential output level.
B. experience a small inflation but aggregate output returns to the potential output level.
C. experience a large inflation but aggregate output remains less than the potential output level.
D. experience a large deflation but aggregate output remains less than the potential output level.​

Answer 1

A

Step-by-step explanation:

Here, we want to know what will happen in the long run after market adjustments when we start from a long run steady state equilibrium.

An increase in income taxes will shift the adjustment to the left. This will cause deflation.

After this adjustment, the net effect will be a small deflation, but output returns to potential level.