Question

If Congress cuts taxes at the same time that businesses become more pessimistic about the economy, what is the combined effect on output, the price level, and employment using the AD/AS diagram?

Short answer

The combined effect will result in a price increase, but the amount demanded and supply will stay unchanged at equilibrium.

Step-by-step solution

Tax cut : 

Tax cuts are decreases in the amount of money paid to the government by taxpayers.

Tax cut impact : 

If the Congress implements policies that result in tax cuts, consumers will have greater discretionary money. As disposable income rises, spending will rise as well. Companies will invest more as a result of the tax decrease. As a result, either an increase in consumption or an increase in investment will cause the AD curve to move to the right.

If enterprises are gloomy about the future, which indicates that the economy is not stable, productivity will fall, reducing aggregate supply.

The supply curve will change leftward from S to S1 in the image above, whereas the demand curve will shift rightward from D to D1.

It is thought that a rise in demand equals a fall in supply. It will result in a price increase, but the amount sought and supply will stay unchanged at equilibrium.