Tax Cuts Boost Disposable Income and Consumption

Steps:

• Increasing the tax-free allowance raises disposable income for all taxpayers, leaving more money for spending.
• Decreasing the marginal tax rate reduces the tax burden on additional earnings, encouraging more work and higher take-home pay.
• Higher disposable income directly increases consumption, a key component of aggregate demand (AD = C + I + G + NX).
• These are fiscal policy changes affecting demand-side behavior, with no direct impact on production costs or capacity, leaving aggregate supply (AS) unchanged.

Why C is correct:

• Income tax reductions increase disposable income, shifting the consumption function upward and expanding AD per Keynesian economics.

Why the others are wrong:

• A: AD rises, not decreases; tax cuts do not contract demand.
• B: AD increases due to higher spending power.
• D: Identical to C, but listed as distinct option (possible error).

Final answer: C