With an aid of AS-AD diagram, explain the effect on price level and output when the government cuts the profit tax rate

When the government cuts profit taxes rates, the investment incentive and confidence increases, so investment expenditure increases and thus the aggregate demand increases. The price level will increase and the output level will increase in the short run.

The inflationary gap will result in an upward pressure on the input prices. In the long run, wages will adjust upward and the SRAS will decrease. The price level will increase and the output will restore to its original level.