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In an economy where Keynesian supply conditions are valid, explain the effects of lowering marginal tax...

In an economy where Keynesian supply conditions are valid, explain the effects of lowering marginal tax rates on the general level of income and prices with the help of the AD-AS model.

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Answer #1

Ans. A decrease im marginal tax rate leads to increase in the disposable income of households, thus, increasing consumption spending. This increase in consumption spending increases aggregate demand for goods and services in the economy shifting the aggregate demand curve to right from AD to AD'. This leads to a shortage of goods and services in the market increasing the price level from P to P'. This increase in price encourages production units to increase the production increasing quantity supplied of goods and services which moves the equilibrium from equilibrium income level Y to Y'.

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