Consider two fiscal policy actions.
I. a $400 billion reduction in income taxes
II. a $400 billion increase in government purchases
Which policy will have a bigger impact on aggregate demand?

Question

Quizplus · Accepted Answer

Policy II will have a bigger impact on aggregate demand because it directly affects government purchases, which are a component of aggregate demand. Policy I works through consumption, which is a component of aggregate demand, but the degree to which it affects consumption depends on the marginal propensity to consume of households, which may vary. Therefore, Policy II is the better choice for directly impacting aggregate demand.

Consider Two Fiscal Policy Actions