Exploring AD and AS

2. In 1975 oil exporting countries curtailed output and raised prices. Economists were unsure about how to treat this event. (a) Some said that it was similar to an increase in taxes. Both imports and taxes are withdrawals from the stream of spending. If one treats this event as similar to taxes, one will get a prediction of the end results from a simple income-expenditure model. What will this model predict about what will happen to unemployment and prices?

(b) Most economists now believe that this is a case of a disturbance that originated in the resource markets. Show how this event can be represented in terms of Figure 2 of Chapter 9. What will the long-run effects be on price level and output? Speculate on what reasonable short-run effects will be.

3. Tax changes alter incentives people face. Suppose a tax increase decreases the amount people want to spend (which fiscal policy predicts), and also decrease the amount they want to produce (a possible incentive effect). What will this tax increase look like in the ISLM model? Can you show the incentive effects? What will it look like in the aggregate demand-supply model?

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