How can taxes affect aggregate supply?

The reasoning behind this choice being correct lies in the relationship between taxes and business behavior regarding investment. Higher taxes on profits, income, or capital gains reduce the net return that businesses receive from their investments. When businesses face increased tax burdens, they may perceive investing in new projects, expanding operations, or hiring additional employees as less appealing. This reduction in investment can lead to a decrease in productive capacity over time, ultimately impacting the aggregate supply in the economy.

When businesses have lower after-tax profits, their ability and willingness to produce goods and services may be hampered, leading to a slowdown in economic growth. This dynamic illustrates how higher taxes can create disincentives for businesses to engage in activities that contribute positively to the economy's supply side.

In contrast, choices that suggest either lower taxes reduce investment incentives or that taxes do not affect production costs overlook the fundamental economic premise that taxes play a critical role in determining the net profitability of investments and, by extension, the overall supply of goods and services in the economy.