Hello,
I ran into this question using Kaplan practice exams and I’m not quite sure I understand the explanation. Can someone please help me out on this and paraphase?
An economy is in full-employment equilibrium. If the government unexpectedly decreases the tax rate, in the short run the economy is most likely to experience:
A. An Increase in employment
B. A decrease in price level
C. No change in employment and an increase in price level
Explaination : “Short-run equilibrium may occur above full employment, for example as a result of an increase in aggregate demand caused by a decrease in taxes. Both employment and the price level increase in the short run.”
Why does price level increase here? I understand that lower taxes stimulate higher aggregate demand but since the demand curve is downward sloping I had thought price level would decrease here. What am I missing?