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Question
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Posted 2 months ago

The Council of Elrond has decided to increase taxes, and the central bank of Elrond has decided to conduct open market purchases of financial assets.

Assuming that wages are sticky, which of the following best describes the impact of these actions on real output and the price level?

Choose 1 answer:
(A) Impact on real output indeterminate; impact on the price level indeterminate
(B) Real output increases; the price level increases
(C) Real output decreases; impact on the price level is indeterminate
(D) Real output will decrease; the price level will decrease
(E) Impact on real output is indeterminate; price level decreases
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Answer from Sia
Posted 2 months ago
Solution by Steps
step 1
The Council of Elrond has decided to increase taxes, which typically reduces disposable income and consumption, leading to a decrease in aggregate demand
step 2
The central bank of Elrond has decided to conduct open market purchases of financial assets, which increases the money supply and typically lowers interest rates, potentially increasing investment and aggregate demand
step 3
Assuming wages are sticky, the immediate effect of increased taxes is a reduction in aggregate demand, which would decrease real output
step 4
The open market purchases by the central bank aim to counteract this by increasing aggregate demand through lower interest rates
step 5
The net effect on real output is indeterminate because the decrease in aggregate demand from higher taxes may be offset by the increase in aggregate demand from lower interest rates
step 6
The price level is likely to decrease because the initial reduction in aggregate demand from higher taxes is not fully offset by the increase in aggregate demand from lower interest rates, especially in the short run with sticky wages
Answer
E
Key Concept
Impact of fiscal and monetary policy on real output and price level
Explanation
The increase in taxes reduces aggregate demand, while open market purchases increase it. The net effect on real output is indeterminate, but the price level is likely to decrease due to the initial reduction in aggregate demand.

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