Final answer:
The LIFO (Last-In, First-Out) method typically leads to the lowest income taxes during a period of rising prices, as it results in a higher COGS and thus lower taxable income. Tax increases reduce consumption and AD, helping combat inflation. A price floor has a substantial impact when set above the equilibrium price. Option B.
Step-by-step explanation:
In a period of rising prices, the inventory method that generally results in the lowest income taxes is the LIFO (Last-In, First-Out) method.
This is because the LIFO method assumes that the most recently acquired items (which cost more due to inflation) are sold first, resulting in higher cost of goods sold (COGS) and lower taxable income compared to FIFO (First-In, First-Out) or Average Cost methods.
To elaborate further, during inflationary times, the prices of goods tend to increase. Consequently, if a company uses the LIFO method, the cost of the latest inventory – which is more expensive – is used up first.
This leads to a higher COGS on the income statement, effectively reducing the net income before taxes. Therefore, with less income reported, less income tax is owed.
On the other hand, the FIFO method would leave the cheaper, older inventory costs in COGS, typically resulting in a higher reported income and higher taxes in times of inflation.
A tax increase on consumer income can lead to a decrease in consumption, shifting the Aggregate Demand (AD) curve to the left, which is a strategy that may be used to control inflation.
Moreover, a price floor will have the largest effect if it is set substantially above the equilibrium price, as it creates a significant surplus by preventing the market from reaching equilibrium.
Hence, the right answer is option B.