Sia
Question
Statistics
Posted 7 months ago
The Council of Elrond has decided to increase taxes, and the central bank of Elrond has decided to conduct open market sales 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) Real output decreases; impact on the price level is indeterminate
(B) Real output increases; the price level increases
(C) Impact on real output is indeterminate; price level decreases
(D) Real output will decrease; the price level will decrease
(E) Impact on real output indeterminate; impact on the price level indeterminate
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Answer from Sia
Posted 7 months ago
Solution by Steps
step 1
To analyze the impact of the policy decisions on real output and the price level, we need to understand the effects of fiscal and monetary policy. Increasing taxes is a fiscal policy that tends to decrease aggregate demand
step 2
Conducting open market sales of financial assets is a monetary policy action that increases the interest rate, which also tends to decrease aggregate demand
step 3
With wages being sticky, the decrease in aggregate demand will not immediately result in lower wages, leading to a decrease in real output
step 4
The decrease in aggregate demand due to both fiscal contraction (tax increase) and monetary contraction (open market sales) will likely lead to a decrease in the price level as well
Answer
D
Key Concept
Fiscal and monetary contraction
Explanation
Increasing taxes and conducting open market sales both decrease aggregate demand, which leads to a decrease in real output and the price level when wages are sticky.
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