Fiscal Policies to Boost Aggregate Demand

Steps:

• Define aggregate demand (AD) as total spending: AD = C + I + G + (X - M).
• Assess each option's impact on AD components: consumption (C), investment (I), government spending (G), and net exports (X - M).
• Identify policies that increase C, I, or G without counteracting effects.
• Select the option with the strongest net positive impact on AD.

Why B is correct:

• Reduction in income tax raises disposable income, increasing consumption (C); higher subsidies reduce production costs, boosting investment (I) and consumption, per the AD formula.

Why the others are wrong:

• A: Tax cut boosts C, but higher interest rates raise borrowing costs, reducing I and C.
• C: Higher taxes lower disposable income and C; increased G raises AD but is offset by tax hike.
• D: Higher VAT reduces consumer spending (C); lower G directly cuts AD.

Final answer: B