Consider a closed economy in which consumption is described by
C = 200 + 0.81 - t)Y. Let the tax rate t = 0.2 and I = 800, and assume an active government so that G = 1,200. If the government balances its budget in equilibrium by increasing the tax rate and decreasing its spending, then
A) GDP climbs above $5,556.
B) GDP remains at $5,556.
C) GDP falls below $5,556.
D) GDP rises or falls depending on which policy is stronger.
E) consumption expenditure either rises or falls depending on whether or not the tax increase dominates the effect of climbing GDP.

Question

Quizplus · Accepted Answer

When the government increases the tax rate and decreases its spending to balance the budget, it reduces aggregate demand, leading to a decrease in GDP below $5,556.

Consider a Closed Economy in Which Consumption Is Described by