Suppose the government reduces its budget deficit at the same time that energy prices rise sharply.Which of the following will happen?

Question

Quizplus · Accepted Answer

When energy prices rise sharply, it increases the cost of production for businesses. If the government reduces its budget deficit at the same time, it means that there will be less government spending and therefore less overall demand in the economy. As a result, these two events together tend to cause an economic contraction leading to a fall in Real GDP. Choice A is not likely because rising energy prices will increase costs and reduce profits, which would put downward pressure on prices. Choice C is incorrect because a decrease in aggregate demand would lead to lower output and employment, which would push prices down only in the short run. Choice D is not likely because the reduction in government spending could offset any potential increase in private sector opportunities unless private investment takes off.

Suppose the Government Reduces Its Budget Deficit at the Same