If government spending is increased by $1,000 and taxes are increased by $1,000, the equilibrium level of income will

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Quizplus · Accepted Answer

When the government increases spending by $1,000, it directly increases aggregate demand and, consequently, the equilibrium level of income. The increase in taxes by $1,000 reduces disposable income, thus reducing consumption. However, the multiplier effect of government spending is typically larger than the multiplier effect of a tax increase because not all of the tax increase would have been spent (some might have been saved). Therefore, the net effect is an increase in the equilibrium level of income, but not by the full $2,000 due to the offsetting effect of higher taxes.

If Government Spending Is Increased by $1,000 and Taxes Are