Question

A policymaker claims that tax cuts led the economy out of a recession. Can we use the AD/AS diagram to show this?

Short answer

Depending on where the tax cuts are focused, they enhance consumer and investment spending. This would move AD to the right, so that if tax cuts were implemented during a recession (and GDP was below potential), GDP would rise and the economy would be "led out of recession."

Step-by-step solution

concept introduction

The total quantity of products and services demanded by consumers at a given price level and period is known as aggregate demand.

The value of total production produced by an economy at a certain price level over a specific time period is known as aggregate supply.

To determine

The impact of the tax cut on the equilibrium level of GDP and price level is still to be determined.

Step 3:Explanation

A tax cut implemented by the government is one of the government's fiscal tools. Any reduction in the tax rate suggests that people have more money in their hands, increasing their spending ability. Consumption is a big component of aggregate demand, hence this will raise aggregate demand.

Only when the economy is far from its potential GDP level will it emerge from recession. An rise in the equilibrium level and price level would result from a rightward shift in the AD curve.