In the short run, when government purchases fall, income and hence consumption fall, so
A)real GDP falls by more than the fall in government purchases.
B)both real GDP and potential GDP fall by the same amount as the fall in government purchases.
C)real GDP falls by the same amount as the fall in government purchases.
D)real GDP falls by less than the fall in government purchases.
E)both real GDP and potential GDP fall by more than the fall in government purchases.

Question

Quizplus · Accepted Answer

This occurs due to the multiplier effect. A decrease in government spending reduces overall demand, leading to a decrease in income and consumption, which in turn reduces real GDP by more than the initial reduction in government purchases.

In the Short Run, When Government Purchases Fall, Income and Hence