How can fiscal policy affect aggregate demand?

• A. By changing the global price of goods
• B. By influencing consumer spending and investment
• C. By eliminating government spending
• D. By altering monetary policy alone

Answer: (B)

Fiscal policy affects aggregate demand primarily by influencing consumer spending and investment. When the government implements changes in taxation or increases public spending, it directly impacts the disposable income of consumers and the operational capabilities of businesses. For example, tax cuts can lead to higher disposable income, prompting consumers to increase their spending on goods and services. Similarly, increased government spending can stimulate demand for products and services, creating a multiplier effect throughout the economy.

Investment can also be affected through fiscal policy. When the government invests in infrastructure or offers tax incentives for businesses, it encourages firms to invest more, boosting overall economic activity. This interconnectedness of fiscal actions and aggregate demand illustrates why the correct answer focuses on how these measures influence the behavior of households and businesses, ultimately affecting the total demand in the economy.