3. If the government were to reduce income taxes, how would the reduction affect output and...

3. If the government were to reduce income taxes, how would the reduction affect output and the price level in the short run? In the long run? Describe how the aggregate supply and aggregate demand curves would be affected?

Expert Solution

Answer -

The agreegate demand and supply curve is essential concept in determining the relationship between price level and level of output in the economy. They shifts as per the fluctuations in economy.

When the Government reduce income tax ,with the reduction in the tax rate disposable income of the people increases and consumption will also increase. It will result in increase in investments as firm will have more capital funds for making new investmennts.

Therefore in the short run agreegate demand curve will shift to right indicaed increase both price and output.

But in the long run short run agreegate supply curve (SARS) will shift to left as now prices and wages starts to adjusting as employees will demand for high wages decreses the supply and make it down .There will be very small change in agreegate supply as increase in labour force and with reduction of tax people will motivate to do more work and earn more.It will result to increase in the rate of GDP.

Rahul Sunny answered 5 months ago

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