In 1981-1983, the Reagan administration implemented a fiscal policy that reduced taxes and increased government spending.

a. Explain why this policy would tend to increase aggregate demand. Show the impact on output and prices assuming only an AD shift.

b. The supply-side school holds that tax cuts would affect aggregate supply mainly by increasing potential output. Assuming that the Reagan fiscal measures affected AS as well as AD, show the impact on output and the price level. Explain why the impact of the Reagan fiscal policies on output is unambiguous while the impact on prices is unclear.