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Consider the Aggregate demand – Aggregate Supply model, suppose
the economy begins in a short run equilibrium with output equal to
potential output.

– Illustrate this scenario in an AS-AD diagram. What is the
initial level of cyclical unemployment?

– Suppose that the government in this economy decides to cut
exogenous taxes. What effect will this have upon our AD-AS diagram?
Make sure to label all the objects in your diagram correctly. What
happens to output and inflation in the short run equilibrium? What
happens to our long run equilibrium? Explain your reasoning.

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