Question

One supply-side measure introduced by the Reagan administration was a cut in income tax rates. Use an aggregate demand-supply diagram to show what the effect was intended. What might happen if such a tax cut also generated a change in aggregate demand?



Draw your supply and demand curves; y axis has general price levels, x axis has GDP. Increase supply (lower taxes leads to greater incentives to work leading to greater output at any given price level. ) What happens to the price level, what happens to GDP?

Now make a case for aggregate demand. (It could shift out as people have more disposable income. This is offset by an an inward shift a government cuts back spending as tax receipts fall). What happens to price, what happens to GDP?