If government spending in a country declines by $10 billion and, at the same time, taxes increase by an equal amount, what is the total effect in the economy?
A) Equilibrium real GDP increases
B) Equilibrium real GDP increases by $20 billion
C) Equilibrium real GDP is unchanged
D) Equilibrium real GDP decreases by more than $10 billion and less than $20 billion
E) Equilibrium real GDP decreases by more than $20 billion

Question

Quizplus · Accepted Answer

When government spending decreases, it directly reduces aggregate demand, leading to a decrease in equilibrium real GDP. An increase in taxes reduces consumers' disposable income, further decreasing consumption and aggregate demand. The combined effect of both actions amplifies the reduction in equilibrium real GDP, making it decrease by more than $10 billion but less than $20 billion due to the multiplier effect.

If Government Spending in a Country Declines by $10 Billion