I’m drawing a blank on a basic theoretical concept that I was thinking of as I watched the VP debate tonight… in the short run, in the ad-as model, tax cuts lead to an increase in AD, thereby increasing both gdp and the price level, ceteris paribus. in the long run, in order to return to the long run equilibrium, the as curve shifts to the left, resulting in an output level equal to what it was prior to the tax cut, but leads to an even higher price level. i think i have all that correct so far…my question though, why is it that the as curve shifts to the left in the long run? i know that it’s returning the LR equilibrium, but what is causing the shift?
Am not sure about this but I suppose that the equilibrium before the tax-cut is the point which is the level of full-employment where capacity of the economy is at its bearable maximum.
Are you talking about Demand-Pull inflation?
jdane416 Wrote: ------------------------------------------------------- > Are you talking about Demand-Pull inflation? Yes, demand-pull inflation.
As I understand it it’s because in the long run people adjust their expectations to the higher price level. Whereas in the short they’re only responding to the increase in the money supply. It’s kind of like finding a twenty on street, buying lottery tickets or whatever with the “free money”, and then realizing that it fell out of your wallet. On a side note I don’t think that’s really the argument of supply sider’s tax cutting argument. That’s more an issue of taxes decreasing the incentive to work, leading to a reduction in the supply of labor, and therefore a drag on GDP through an increased cost in a factor of production.