In the event consumers expected a tax cut in the future, forward-looking consumption behavior on their part would bring about
A) a leftward shift of the IS curve as they anticipated higher future budget deficits.
B) a leftward shift of the IS curve in response to an expected decrease in government future benefits.
C) a rightward shift of the IS curve since they perceive their lifetime disposable income to have increased.
D) a rightward shift of the IS curve in response to an expected decrease in government future benefits.
E) a leftward shift of the IS curve since they perceive their lifetime disposable income to have increased.

Question

Quizplus · Accepted Answer

A tax cut expected in the future would lead consumers to anticipate an increase in their future disposable income. According to the permanent income hypothesis, consumers smooth their consumption over time based on their expectations of lifetime income. Therefore, expecting higher future income, consumers are likely to increase their current consumption, which would increase aggregate demand. This is represented by a rightward shift of the IS curve, which shows the relationship between interest rates and the level of income that brings the goods market into equilibrium.

In the Event Consumers Expected a Tax Cut in the Future