If government spending in a country declines by $10 billion and, at the same time, taxes increase by an equal amount, what is the total effect in the economy?
A)Equilibrium real GDP increases
B)Equilibrium real GDP decreases by $20 billion
C)Equilibrium real GDP is unchanged
D)Equilibrium real GDP decreases by more than $10 billion and less than $20 billion
E)Equilibrium real GDP decreases by more than $20 billion

Question

Quizplus · Accepted Answer

The decrease in government spending reduces aggregate demand, and the increase in taxes further reduces disposable income and consumption. The combined effect is a decrease in GDP, but the exact amount depends on the marginal propensity to consume, making it more than $10 billion but less than $20 billion.

If Government Spending in a Country Declines by $10 Billion