Question

Everything else held constant, a balanced budget increase in government spending (that is, an increase in government spending that is matched by an identical increase in net taxes) will A) increase aggregate demand, but not by as much as if just government spending increases. B) increase aggregate demand by more than if just government spending increases. C) not affect aggregate demand. D) decrease aggregate demand.

Answer 1

Answer: Option (A) is correct.

Explanation:

Other things remains constant, a increase in the balanced budget means that the amount by which government spending increases is offset by the identical increase in net taxes.

Increase in government spending will lead to increase the aggregate demand in the economy whereas increase in the net taxes will lead to fall in aggregate demand.

Here both increases by the same amount, but still there is an increase in the aggregate demand but the amount by which aggregate demand increases is less than the amount by which government spending increases.

This is because of the impact of tax and government spending multiplier. Tax multiplier is smaller than the government spending multiplier. All of the increase in government spending will going towards increase the aggregate demand but in taxes a portion of consumption decreased with decrease in the disposable income.