A temporary tax cut is not likely to be effective in stimulating aggregate demand if _____
A) the tax cut is large.
B) the MPC is relatively high.
C) the economy experiences a contractionary gap.
D) the short-run aggregate supply curve is relatively flat.
E) people base consumption decisions on the level of their permanent income.

Question

Quizplus · Accepted Answer

A temporary tax cut may not effectively stimulate aggregate demand if people base their consumption decisions on their permanent income rather than their current income. This concept, known as the permanent income hypothesis, suggests that temporary increases in income (such as those from a short-term tax cut) will not significantly alter consumption patterns, as individuals consider their long-term financial outlook when making spending decisions.

A Temporary Tax Cut Is Not Likely to Be Effective