Chapter 17, Problem 1.1P

To determine

The predictions of the Keynesian economic theory.

Explanation of Solution

Using the aggregate demand-supply model, the likely effects of the major tax cut when the economy is not operating at a capacity and the Fed accommodates by increasing the money supply is depicted in Figure 1.

In Figure 1, the horizontal axis depicts the aggregate output (GDP) and the vertical axis depicts the price level. The likely effects of the major tax cut when the economy is not operating at a capacity and the Fed accommodates by increasing the money supply is the increase in the level of real GDP which is likely to be inflationary in nature. The effect on the price level depends on the level of closeness to the capacity the economy is operating.

Economics Concept Introduction

Concept Introduction:

Real Gross Domestic Product (Real GDP): Real GDP refers to the market value of all the final goods and services produced in an economy during an accounting year, measured at constant prices.

Aggregate demand (AD): An aggregate demand refers to the total value of the goods and services that are demanded at a particular price within a given period of time.

Aggregate supply: An aggregate supply is the total value of supply of the final goods and services in an economy within a given period of time.