Question

Tax cuts will likely affect aggregate demand and aggregate supply. Does it matter which is affected more? Explain in terms of the AD-AS framework.

Answer 1

Tax cut will affect the aggregate demand more as the disposable income in the market will increase and that will shift the aggregate demand curve to the right, the new equilibrium will be at a higher price and higher output in the market. It will not affect the aggregate supply much because the tax cuts are small most of the time and targeted for the personal income ta payers it have negligible effect on the functioning of the firm in the market.

So, the tax cuts increase the disposable income that shifts the aggregate demand and new equilibrium will be at a higher price and higher output.