Household Income Tax Cut
The question
Assume the economy of Ravenna is initially in long-run equilibrium. The legislature of Ravenna passes a large cut in the personal income tax paid by households, raising the disposable income that families have available to spend. Show the short-run effect of this policy on Ravenna's economy, assuming the central bank takes no action. Show the effect on the AD-AS Model graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Household Income Tax Cut: the worked answer
On the AD-AS Model graph, AD shifts right.
Why AD shifts right
A cut in the personal income tax raises households' disposable income, and with more take-home pay households increase consumption at every price level. Consumption is a component of aggregate demand, so aggregate demand shifts to the right. The tax cut does not change firms' per-unit production costs or the economy's resource base and technology, so neither the short-run nor the long-run aggregate supply curve shifts.
What happens to the equilibrium
The equilibrium price level rises and real GDP increases above full-employment output in the short run.
The mistake students make on this one
Many students shift SRAS right, having learned that lower taxes lower costs. That rule applies to per-unit taxes levied on firms' output; a personal income tax is paid by households, so it works through disposable income and consumption and therefore moves AD.
On exam day
Ask who writes the check. A tax on households moves AD through C, while a per-unit tax or subsidy on firms moves SRAS through per-unit cost.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when AD shifts right and every other curve on the AD-AS Model graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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