Let taxes be set equal to T, consumption be given by C = a + bY - T), investment and government spending be exogenous, and net exports be characterized by X = g - mY. Suppose both T and G increase by $10 billion. How much would equilibrium GDP increase?
A) It would increase by $10 billion.
B) It would increase by less than $10 billion.
C) It would increase by more than $10 billion.
D) It would be unaffected, since the federal deficit would be unchanged.
E) It would increase by more or less than $10 billion depending on the values assumed by a, b, g, and m.

Question

Quizplus · Accepted Answer

An increase in both T and G by $10 billion would have a smaller net effect on GDP because the increase in taxes reduces disposable income and consumption, partially offsetting the increase in government spending.

Let Taxes Be Set Equal to T, Consumption Be Given