short run keynesian model with flexiable wages and adaptive expectations. Taxes decline. Explain and diagratically represnt what happens to P,Y,W, and N.
Key intuition
A decline in taxes raises disposable income, so consumption and aggregate demand (AD) increase. Diagrammatically this is an outward (rightward) shift of the AD curve. In the short run this raises output (Y) and the price level (P). With flexible nominal wages and adaptive expectations, nominal wages (W) begin to rise as firms bid for labor and workers update wage demands; employment (N) rises initially with the expansion in output. Over time, as expectations adapt, rising expected prices feed into wage-setting and the short-run aggregate supply (SRAS) shifts left, pushing prices higher and moving output back toward its natural level while wages remain higher.
Short-run (immediate) effects
P (price level): rises
Y (real output): rises
W (nominal wages): begin to rise (may adjust gradually)
N (employment): rises
Medium run (after adaptive expectations update)
SRAS shifts left as expected prices/wages rise.
P: rises further (higher than initial short-run level).
Y: moves back toward the natural (potential) output.
W: higher (nominal wages have adjusted upward).
N: returns toward the natural rate of employment.
AD-AS diagram: AD₀ → AD₁; SRAS₀ → SRAS₁ as expectations adapt.
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