Assertion (A): A cut in the proportional income tax rate shifts the aggregate demand line upward and makes it steeper.
Reason (R): A decrease in the tax rate works in effect like an increase in the propensity to consume.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): A cut in the proportional income tax rate shifts the aggregate demand line upward and makes it steeper. — True. With a proportional tax, the slope of the aggregate demand line is c(1 − t). A lower t makes this slope larger, so the line turns steeper and moves up.
Reason (R): A decrease in the tax rate works in effect like an increase in the propensity to consume. — True. After the tax cut, households keep a bigger part of every extra rupee of income, so they spend more out of income.
Why R explains A?
The slope of the aggregate demand line is the propensity to consume out of income, c(1 − t). R says a tax cut raises this propensity. A higher slope gives a steeper line that lies higher at every positive level of income, and income rises from Y to Y′.
NCERT (2026-27): “Box 5.1: Fiscal Policy We note that proportional taxes not only lower consumption at each level of income but also lower the slope of the consumption function. The mpc out of income falls to c (1 – t). …” “… The decrease in taxes works in effect like an increase in propensity to consume as shown in Fig. 5.5. The AD curve shifts up to AD′. At the initial level of income, aggregate demand for goods exceeds output because the tax reduction causes increased consumption. The new higher level of income is Y′.” |