Decrease in Aggregate Demand Lowers Inflation

Steps:

• Inflation decreases when aggregate demand (AD) falls relative to aggregate supply (AS), reducing price pressures.
• Assess each option's effect on AD components: consumption, investment, government spending, net exports.
• Options A, B, and D increase or mixed-impact AD, while C clearly reduces it.
• Conclude C causes the largest AD contraction, leading to disinflation.

Why C is correct:

• Higher direct taxes reduce disposable income, cutting consumption; falling investment directly lowers AD (Keynesian AD formula: AD = C + I + G + (X - M)).

Why the others are wrong:

• A: Increased government spending boosts AD; lower marginal propensity to save raises consumption, accelerating inflation.
• B: Lower interest rates stimulate borrowing and spending, increasing consumption and investment to raise AD and inflation.
• D: Rising import prices cause cost-push inflation; falling export demand reduces net exports but cost effects dominate, likely increasing inflation.

Final answer: C