Suppose an economic advisor to the President recommended a personal income tax increase. Indicate the expected effects on aggregate demand and on aggregate supply.

What will be an ideal response?

The advisory would recommend this in hopes of dampening consumer demand and lessening demand-pull inflation. This should happen as consumers find themselves with less disposable income. However, at the same time there may be some less desirable effects on aggregate supply. For example, workers might demand higher wages to compensate for the higher taxes. Higher taxes may cause lessened work incentives which could cause a decline in productivity and, therefore, a rise in production costs. In other words, while raising personal taxes seems to be a correct policy for dampening demand and demand-pull inflation, it may have an offsetting effect on supply which could cause cost-push inflation.