5 Questions
What is the direct effect of an increase in government spending on aggregate demand?
It increases aggregate demand
What is the effect of an increase in taxes on aggregate demand?
It decreases aggregate demand
What happens to aggregate demand when the government increases its spending and simultaneously increases taxes to finance the spending?
It depends on the size of the spending increase and the tax increase
Which of the following best describes the effect of an expansionary fiscal policy on aggregate demand?
It increases aggregate demand
What is the likely effect of a contractionary fiscal policy on the overall level of economic activity?
It decreases the overall level of economic activity
Study Notes
Fiscal Policy and Aggregate Demand
- An increase in government spending directly increases aggregate demand, as it adds to the overall demand for goods and services in the economy.
- An increase in taxes, on the other hand, decreases aggregate demand, as it reduces the disposable income of individuals and businesses, leading to lower consumption and investment.
- If the government increases its spending and simultaneously increases taxes to finance the spending, the net effect on aggregate demand is uncertain, as the increase in spending boosts demand, but the increase in taxes reduces it.
- An expansionary fiscal policy, which involves increasing government spending or cutting taxes, shifts the aggregate demand curve to the right, increasing the overall level of economic activity.
- A contractionary fiscal policy, which involves decreasing government spending or increasing taxes, shifts the aggregate demand curve to the left, decreasing the overall level of economic activity.
Test your understanding of how government spending and taxation affect aggregate demand. Learn about the effects of expansionary and contractionary fiscal policies.
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