When taxes increase, consumption decreases. How is this situation represented in the aggregate demand and aggregate supply model?
A) by a movement to the left along a given aggregate-demand curve
B) by shifting aggregate demand to the left
C) by shifting aggregate supply to the left
D) by a movement to the right along a given aggregate-demand curve

Question

Quizplus · Accepted Answer

When taxes increase, households have less disposable income, which decreases consumption. This leads to a decrease in aggregate demand, which is represented by a leftward shift of the aggregate demand curve. Option A is incorrect because a movement to the left along a given aggregate-demand curve represents a decrease in aggregate demand due to a change in a variable other than the price level (such as a decrease in government spending). Option C is incorrect because a shift in aggregate supply occurs due to changes in production costs, which are influenced by factors such as technology, wages, and input prices. Option D is incorrect because an increase in consumption would lead to a movement to the right along a given aggregate-demand curve, not a decrease.

When Taxes Increase, Consumption Decreases