Suppose the economy is initially operating at full employment. A reduction in the size of the budget deficit will cause which of the following in the short run?
A) a recessionary gap.
B) an increase the price level and a reduction in real GDP.
C) an increase in the price level with no change in real GDP.
D) an increase in real GDP and an increase in the price level.

Question

Quizplus · Accepted Answer

A reduction in the size of the budget deficit, typically achieved through decreased government spending or increased taxes, would lead to a decrease in aggregate demand. This decrease in aggregate demand, when the economy is initially at full employment, can cause a recessionary gap, where actual GDP falls short of potential GDP, leading to increased unemployment and underutilized resources.

Suppose the Economy Is Initially Operating at Full Employment