Question

For each of the following scenarios, please decide whether there will be an increase, decrease, or no change in aggregate demand.

a. The United States government decides to increase the federal tax rate by 4% for all earners.
b. The Federal Reserve, the agency charged with regulating banking and monetary policy in the United States, decides to increase the amount of money available in the economy.
c. The newest release of the Consumer Confidence Index shows a steady increase in consumer confidence about the economy.
d. A manufacturing boom during the late 1990s has created an oversupply of tractors, a necessary implement in agricultural production.

Answer 1

a. Decrease

If the Federal government increases taxes on people, they will have less money to spend and save after paying their taxes. This will reduce their consumption and investment (savings) thereby leading to a lower aggregate demand.

b. Increase

An increase in the money supply means that people will have more money to spend on goods and services. They will therefore consume more. More money in the economy reduces interest rates so people will borrow to invest more as well. These two things will combine for an increase in aggregate demand.

c. Increase

If consumers are more confident about their economy, it means they find it safe to invest in it. As they invest, the investment component of aggregate demand would rise which would increase aggregate demand.

d. Decrease

The oversupply from recent years will mean that investment required in recent years will be less. This will lead to a lower aggregate demand.