Multiple Choice
Which of the following combinations of monetary and fiscal policy is most likely to reduce unemployment in an economy?
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19. Fiscal Policy
Introduction to Fiscal Policy
Multiple Choice
Which of the following represents the most contractionary fiscal policy?
A
A decrease in government spending and no change in taxes
B
An increase in taxes and a decrease in government spending
C
A decrease in taxes and an increase in government spending
D
An increase in government spending and no change in taxes
Verified step by step guidance1
Step 1: Understand what contractionary fiscal policy means. It is a policy aimed at reducing aggregate demand to slow down economic activity, often to control inflation. This is typically done by decreasing government spending, increasing taxes, or both.
Step 2: Analyze each option in terms of its effect on aggregate demand. A decrease in government spending reduces aggregate demand, while an increase in taxes also reduces disposable income, leading to lower consumption and aggregate demand.
Step 3: Compare the options:
- A decrease in government spending and no change in taxes reduces demand only through spending.
- An increase in taxes and a decrease in government spending reduces demand through both lower government spending and lower consumer spending.
- A decrease in taxes and an increase in government spending increases aggregate demand, which is expansionary, not contractionary.
- An increase in government spending and no change in taxes increases aggregate demand, also expansionary.
Step 4: Conclude that the most contractionary fiscal policy is the one that combines both an increase in taxes and a decrease in government spending, as it reduces aggregate demand from two sides.
Step 5: Summarize that contractionary fiscal policy involves reducing government spending and/or increasing taxes, and the option with both changes is the strongest contractionary measure.
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