Other things being equal, an increase in government spending financed by higher taxes reduces real GDP because it causes both aggregate demand and aggregate supply to decline.

Question

Quizplus · Accepted Answer

An increase in government spending financed by higher taxes may initially cause a decline in aggregate demand due to a reduction in disposable income for households and less investment by businesses, but it also increases aggregate supply by funding projects that enhance productivity and encourage economic growth. The net effect on real GDP is uncertain and depends on various factors such as the magnitude of the spending and the efficiency of the projects funded.

Other Things Being Equal, an Increase in Government Spending Financed