An increase in government spending raises income:
A) and the interest rate in the short run, but leaves both unchanged in the long run.
B) in the short run, but leaves it unchanged in the long run, while lowering investment.
C) in the short run, but leaves it unchanged in the long run, while lowering consumption.
D) and the interest rate in both the short and long runs.

Question

Quizplus · Accepted Answer

When there is an increase in government spending, it leads to an increase in aggregate demand in the short run, which leads to an increase in income. However, in the long run, the economy adjusts and returns to its potential level of output, leaving income unchanged. This is known as the crowding out effect, where increased government spending leads to higher interest rates which discourage private investment and thus lower future growth potential. Therefore, in the long run, government spending does not boost income.

An Increase in Government Spending Raises Income