Congress is debating whether to raise taxes by $100 billion or decrease spending by $100 billion in order to eliminate a budget deficit.Which action will have the larger effect on equilibrium GDP?
A)The increase in taxes
B)The decrease in spending
C)The effects will be equal
D)Not possible to determine without knowing the multiplier

Question

Quizplus · Accepted Answer

When the government decreases spending by $100 billion, it directly reduces the aggregate demand in the economy by the same amount, which leads to a reduction in equilibrium GDP. However, an increase in taxes by $100 billion reduces the disposable income of households and leads to a decrease in consumption expenditure, which further reduces the equilibrium GDP. The size of the effect will depend on the multiplier, but generally, decreasing spending has a larger effect on equilibrium GDP than increasing taxes.

Congress Is Debating Whether to Raise Taxes by $100 Billion