Use the following to answer questions: Figure: Policy Alternatives -(Figure: Policy Alternatives) Refer to Figure: Policy Alternatives. If the economy is in equilibrium at Y₁ in panel (a) and the government decreases taxes, the result will likely be a(n): A) increase in unemployment. B) decrease in interest rates. C) decrease in aggregate demand. D) increase in aggregate demand.

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If the government decreases taxes, it will increase disposable income which will lead to an increase in consumption. This will shift the aggregate demand curve to the right resulting in an increase in equilibrium output and prices. Therefore, the correct answer is an increase in aggregate demand. Option (A) is incorrect because a decrease in taxes will not lead to an increase in unemployment. Option (B) is incorrect because according to the AD-AS model, a decrease in taxes will increase aggregate demand which will lead to an increase in interest rates. Option (C) is incorrect because a decrease in taxes will lead to an increase in aggregate demand not a decrease.

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