AP Macroeconomics Question 291: Answer and Explanation

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Question: 291

4. Which of the following choices is most likely to create the greatest decrease in real GDP?

  • A. The government decreases spending, matched with a decrease in taxes.
  • B. The government increases spending with no increase in taxes.
  • C. The government decreases spending with no change in taxes.
  • D. The government holds spending constant while increasing taxes.
  • E. The government increases spending, matched with an increase in taxes.

Correct Answer: C

Explanation:

C —Look for choices that decrease GDP by the largest magnitude. Choices B and E actually improve the economy (and GDP), so they are eliminated. A decrease in spending lowers GDP by a magnitude equal to the spending multiplier, which is larger than the tax multiplier, which in turn is larger than the balanced budget multiplier. This question is a prelude to fiscal policy.