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Evaluate the following situations affecting the aggregate demand curve.(2+2-4 marks) (G) If the government cuts personal income taxes, what will happen to aggregate demand and demand curve, (1+1=2 marks), and (ii) If the government increases the taxes, what will happen to aggregate demand and demand curve Support our answer with diagram. (1+1-2 marks) End of Question Paper. Good Luck.

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Answer #1

1.

When government cuts personal income tax, then it increases the disposable income of the consumers. It makes consumption to increase and aggregate demand increases as well. As a result, aggregate demand curve will shift to the right. It is the case of expansionary fiscal policy. Here, the increase in AD is dependent upon MPC and tax multiplier.

Price AS 132 AD1 Real output

2.

If government increases the tax, then disposable income decreases that is used for the consumption according to the MPC and tax multiplier magnifies it in the economy. It leads to the decrease in aggregate demand and AD curve shift to the left. It is a case of contractionary fiscal policy.

Price AS AD1 Real output

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