Final answer:
When the federal government cuts tax rates, they are implementing expansionary fiscal policy, which can lead to increased aggregate demand, higher output, and potentially higher prices. Employment is likely to increase as businesses hire more workers to meet higher demand.
Step-by-step explanation:
When the federal government decides to cut tax rates, they are engaging in expansionary fiscal policy. This type of policy is aimed at stimulating economic growth, particularly in times of recession. By reducing tax rates, households have more disposable income, which can lead to increased consumer spending. Likewise, when companies pay less in taxes, they may increase investments in their business activities. The overall increase in spending generally contributes to higher aggregate demand.
Following the tax cut, if aggregate demand increases by 50 at every price level, the new equilibrium will occur where the aggregate demand curve intersects with the aggregate supply curve at a higher level of output. This shift usually results in a higher level of output and, depending on the slope of the aggregate supply curve, an increase in the price level. As output rises, businesses typically need to hire more workers to meet the higher demand for their products or services, which can lead to a decrease in unemployment rates.
In the short term, these changes can boost economic growth and reduce unemployment. Over the long term, however, consistent tax cuts without equivalent spending reductions can lead to increased budget deficits and potential inflationary pressures if the economy is already operating at or near full capacity.