A tax cut should lead to higher investment spending, which will lead to the AD shifting to the right. But, if this happens, the price level should go up. But why would tax cuts increase price level?? Just doesn’t make sense to me.
Personal income taxes increases consumption spending (not investment spending), which increase AD. Draw AD. When AD increases the equilibrium price level increases. Just like the regular demand/supply graph. If there is a greater demand, prices rise.
Tax cuts are tricky. They increase investment and consumption and lead to lower resources prices as businesses have to pay less. A decrease in LRAS and an increase in AD lead to an increase in output but the price level is indeterminate. A lot of things in an econ class are double shifters. They will tell u to focus on demand or supply so u can make a decision.
Thanks! I started thinking too deep into it.
Krish, this really depends upon the tax cut. If it is a tax cut on businesses or on businesses buying investment goods, then yes, it can increase SRAS and LRAS along with AD. A tax cut on consumers could increase savings, which would increase SRAS and LRAS, but generally AP does not go into that much depth.