Question

Suppose the inflation rate remains relatively constant while output decreases and the unemployment rate increases. Using an aggregate demand and supply graph, show how this scenario is possible.

Short answer

The impact of a national sales tax adoption on aggregate supply and demand curves.

Step-by-step solution

Step 1. Concept of national sales tax 

The national sales tax is a tax paid on consumers at the point of sale on the consumption of goods and services.

Step 2. Explanation

The following diagram depicts the impact of a national sales tax on the aggregate supply and demand curve:

Where, in Figure $1$,

- The long run aggregate supply curve is abbreviated as LRAS.

- AS is the aggregate supply curve in the near run.

- The aggregate demand is abbreviated as AD.

The implementation of a national sales tax would raise manufacturing costs, causing the short-run aggregate supply curve to shift leftward from AS to AS$1$. After the leftward shift of the short run aggregate supply curve, a new intersection will emerge with higher inflation at $1$ and low output at Y$1$. As a result of the implementation of the national sales tax, inflation will rise and output will decrease.