Answer to Question #90522 in Macroeconomics for Sung Eun Seok

Question

14. If government expenditure is increased by $200 billion and simultaneously taxes increase by
$200 billion, then
Select one:
A. aggregate demand decreases.
B. aggregate demand increases
C. aggregate demand does not change.
D. potential GDP increases.

Answer 1

C. aggregate demand does not change.

Government expenditure is one of the components of aggregate demand. When there are changes in any of the aggregate demand components, the aggregate demand either increases or decreases. Thus, if government expenditure is increased by $200 billion, the aggregate demand curve will shift to the right, that is the aggregate demand increases. Also an increase in taxes will reduce the level of consumption in the economy which leads to a decrease in aggregate demand since disposable income and savings will reduce. Thus, when taxes increase by

$200 billion, the aggregate demand will shift to the left that is aggregate demand will decrease.

 Since, the increase in government expenditure leads to an increase in aggregate demand by $200 billion and the increase in taxes by $200 billion leads to a decrease in aggregate demand by the same amount, the aggregate demand will not change but rather remains the same.

Reference

Aggregate Demand (AD) Curve. (2019). Retrieved from https://www.cliffsnotes.com/study-guides/economics/aggregate-demand-and-aggregate-supply/aggregate-demand-ad-curve