Because of the multiplier effect,if a shock causes aggregate demand to increase by $200 million,then the government should _____ in order to restore the economy back to its original growth rate.
A) do nothing
B) increase government spending by more than $200 million
C) reduce government spending by less than $200 million
D) increase government spending by $200 million and cut taxes by $200 million

Question

Quizplus · Accepted Answer

The multiplier effect refers to the phenomenon where changes in spending have a larger impact on the economy than the initial change in spending itself. If a shock causes aggregate demand to increase by $200 million, it means that there has been a positive demand shock in the economy. In order to restore the economy back to its original growth rate, the government should reduce its own spending by less than $200 million, which will dampen the initial increase in demand caused by the shock. By doing so, the economy will return to its original state without overshooting. If the government were to increase its own spending by more than $200 million, it would amplify the initial shock and cause the economy to overshoot its original growth rate. Therefore, the best choice is C.

Because of the Multiplier Effect,if a Shock Causes Aggregate Demand