Final answer:
A permanent tax cut will likely stimulate greater consumer spending and have a more substantial impact on aggregate demand compared to a temporary tax cut, as it indicates a lasting increase in disposable income, leading to significant adjustments in spending habits.
Step-by-step explanation:
When comparing policies—a tax cut that lasts for only one year and a tax cut that is expected to be permanent—we can expect different impacts on consumer spending and aggregate demand. A permanent tax cut is more likely to stimulate greater spending by consumers than a temporary one. This is because individuals and businesses tend to base their spending decisions on long-term expectations. A permanent tax cut suggests a lasting increase in disposable income, leading people to adjust their spending habits upward more significantly than they would with a temporary tax boost that they know will soon expire.
In terms of impact on aggregate demand, a permanent tax cut will likely have a greater effect. A sustained increase in disposable income from the permanent tax cut can result in a larger multiplier effect as the initial spending induces more rounds of spending throughout the economy. Therefore, a permanent tax cut generally leads to a more substantial increase in aggregate demand compared to the temporary one, which may induce only a modest and short-lived boost in demand.