Question

How does a change in income taxes primarily affect aggregate demand?

A. An income tax change alters government purchases by an equal amount.
B. An income tax change alters disposable income and consumption spending.
C. An income tax change alters investment by an equal and opposite amount.
D. A tax change alters exports and net exports.
E. An income tax change alters saving by an equal amount.

Answer 1

B. An income tax change alters disposable income and consumption spending. A change in income taxes primarily affects aggregate demand by altering disposable income and consumption spending.

Step-by-step explanation:

Tax policy can affect aggregate demand by altering consumption and investment spending. A change in income taxes will primarily affect aggregate demand by altering disposable income and consumption spending. Specifically, a decrease in income taxes will increase disposable income, resulting in an increase in consumption demand. Conversely, an increase in income taxes will decrease disposable income and diminish consumption demand.

For example, if the government implements a tax cut for individuals, individuals will have more disposable income. This will lead to an increase in consumption spending, as individuals have more money to spend on goods and services. As a result, aggregate demand will increase, shifting the aggregate demand curve to the right.

Therefore, option B is the correct answer.