1. Supply-Side Economics Personal Income Tax Cuts—Designed to Increase Labor Supply Reduction in tax rate (t). Review chapter 10. Business Tax Cuts—Designed to Increase Investment & Capital Formation

2. A Supply-Side Tax Cut: Reduction in tax rate (t) - Supply-Side Effects P Y AD 0 AS 0 P0P0 P1P1 Y0Y0 Y1Y1 AS 1 Due to t ↓ A B

3. A Supply-Side Tax Cut: Reduction in tax rate (t) – Supply and Demand -Side Effects P Y AD 0 AS 0 P0P0 P1P1 Y0Y0 Y1Y1 AS 1 Due to t ↓ AD 1 Due to t ↓ Y2Y2 Supply-side advocates argued that a reduction in the tax rate (t) would raise tax revenues, i.e., tY↑ => deficit decreases over time A B C

4. A Supply-Side Tax Cut: The Big Question – how large is the effect on AS? 4 of 23 P Y AD 0 AS 0 P0P0 Y0Y0 Y3Y3 AS 1 Due to t ↓ AD 1 Due to t ↓ Y2Y2 The increase from Y 0 to Y 1 may be very small and Y 3 turns out to be a lot less than Y 2 and tax revenues go down => deficit increases. A B C C’ Y1Y1