Assume that the economy is operating below its potential output.Under these conditions,government fiscal policy should be directed toward a(n):
A)decrease in both government purchases and taxes
B)decrease in government purchases and/or tax increases
C)increase in government purchases and/or tax cuts
D)increase in both government purchases and taxes
E)change in neither government purchases nor taxes

Question

Quizplus · Accepted Answer

When the economy is operating below potential output, the government can use fiscal policy to increase aggregate demand and push the economy towards full employment. In this situation, increasing government purchases or cutting taxes (or a combination of both) can stimulate consumer and business spending, which leads to increases in aggregate demand, output, and employment. Therefore, the best choice is C, an increase in government purchases and/or tax cuts. A decrease in government purchases and/or tax increases, as proposed in option B, would likely lower aggregate demand and worsen the economic situation. A decrease in both government purchases and taxes, as proposed in option A, would have a similar effect. Option D would likely have inflationary effects and an adverse impact on consumer spending. Option E would not have any impact on the economic situation.

Assume That the Economy Is Operating Below Its Potential Output