Question

Can taxes be used to control inflation? Use an Aggregate-Supply and Aggregate-Demand diagram to address the question. Note: in contemporary U.S. policy debate, taxes are usually discussed in terms of effect on (real) GDP or budget balance. Why do you think taxes are not often discussed in terms of the price level?)

Answer 1

Yes, taxes can be used to control the inflation in the economy, When the government increase the taxes the disposal income of the people decrease and they demand less, that will shift the aggregate demand curve to the left and the new equilibrium will be at a lower price and lower the quantity.

Here, the equilibrium was at A and the new equilibrium after an increase in the tax is at B. It shifted the demand curve to the left.

Tax is termed on its effect on the GDP and not on the price level because taxes are fiscal policy and can be bring in only once a year with the budgets, price control need more frequent action.