Question

Suppose the government decided to implement a tax cut to spur consumer spending, but everything else in the economy remained the same. What is the likely impact on overall economic activity?

a) Inflationary pressures increase
b) Unemployment decreases
c) Stock market volatility rises
d) Exchange rates stabilize

Answer 1

A tax cut implemented by the government to spur consumer spending can have a positive impact on overall economic activity. It can lead to inflationary pressures, decrease in unemployment, rise in stock market volatility, and stabilize exchange rates.

Step-by-step explanation:

A tax cut implemented by the government to spur consumer spending can have a positive impact on overall economic activity. When consumers have more money due to tax cuts, they are likely to spend more on goods and services, leading to an increase in aggregate demand (AD).

This increase in AD can lead to several effects:

1. Inflationary pressures may increase: If the increase in consumer spending is not matched by an increase in the production of goods and services, it can lead to demand-pull inflation. This occurs when demand exceeds supply, causing prices to rise.
2. Unemployment may decrease: As demand for goods and services increases, businesses may need to hire more workers to meet the higher demand. This can result in a decrease in unemployment rates.
3. Stock market volatility may rise: Tax cuts can have a positive impact on the stock market, but they can also lead to increased volatility. Changes in tax policies and their impact on corporate earnings can affect investor sentiment and result in fluctuations in stock prices.
4. Exchange rates may stabilize: Implementing tax cuts can make a country's economy more attractive to foreign investors. This can lead to an increase in the demand for the country's currency, stabilizing exchange rates.