The tax cut will have a larger impact on aggregate demand in the economy with the:

• A. highest rate of inflation
• B. lowest level of government spending
• C. lowest marginal propensity to save
• D. highest marginal propensity to consume

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the relationship between tax cuts and aggregate demand. A tax cut increases disposable income, which can lead to higher consumption and thus increase aggregate demand.
2. Step 2: Recall the concept of the Marginal Propensity to Consume (MPC), which measures the fraction of additional income that households spend on consumption rather than saving. The higher the MPC, the more of the tax cut will be spent.
3. Step 3: Recognize that the Marginal Propensity to Save (MPS) is complementary to MPC, where \(\text{MPS} = 1 - \text{MPC}\). A lower MPS means a higher MPC, leading to a larger increase in consumption from a tax cut.
4. Step 4: Analyze why other options like the highest rate of inflation or the lowest level of government spending are less directly related to the immediate impact of a tax cut on aggregate demand compared to MPC.
5. Step 5: Conclude that the tax cut will have the largest impact on aggregate demand in an economy with the highest MPC, because more of the additional disposable income from the tax cut is spent, amplifying the effect on aggregate demand.