The government increases taxes. As a result, in the short run, real GDP and the price level
)
A) decreases; rises
B) increases; falls
C) decreases; falls
D) increases; rises

Question

Quizplus · Accepted Answer

When the government increases taxes, it decreases disposable income and reduces consumer spending, which leads to lower aggregate demand. This, in turn, decreases real GDP in the short run. At the same time, the increase in taxes raises production costs for firms, which causes them to raise prices, leading to an increase in the price level. Therefore, real GDP falls, and the price level also falls.

The Government Increases Taxes