Final answer:
The correct answer is that increases in taxes lead to a decrease in disposable personal income and consumption spending, thus reducing the economic multiplier. Tax reductions have the opposite effect, increasing disposable income and potentially amplifying the multiplier due to higher consumer spending.
Step-by-step explanation:
The subject matter concerns the relationship between personal income tax, disposable income, and economic multipliers. In response to the student's question, the correct answer is A) Increases in taxes decrease disposable personal income and lead to a reduction in consumption spending. This is because taxes paid are a portion of income, and when they increase, the amount of income available to individuals for consumption and saving, known as disposable income, decreases. Consequently, this negatively impacts consumer spending, which is a significant component of aggregate demand in an economy. A reduction in consumer spending, therefore, results in a lower multiplier effect. Conversely, tax reductions lead to an increase in disposable income, boosting consumption and potentially amplifying the multiplier effect due to an increase in economic activity driven by higher consumer spending. The actual influence of a tax cut on consumption and saving also takes into account the marginal propensity to consume (MPC). If the marginal propensity to consume is high, a large portion of every additional dollar of disposable income will be used for consumption, which has a direct effect on increasing the multiplier.