ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -When government decreases its spending, it reduces aggregate demand, and causes some real GDP contraction. That contraction eliminates jobs, and less workers earn income. That reduction in income slows consumer spending, which reduces aggregate demand even more, and causes additional real GDP contraction.

Detailed explanation-2: -Reduction in government spending will reduce the level of aggregate demand, which will lead to fall in the income and purchasing power of the people. (The extent of fall in the income and purchasing power depends on the size of multiplier).

Detailed explanation-3: -In particular, one study by the St. Louis Federal Reserve found that government spending has little to no impact on inflation. In fact, a 10% increase in government spending may lead to a 0.08% decline in inflation.

Detailed explanation-4: -Textbook macroeconomic theory holds that unless there are slack resources in the economy, an increase in government spending will put upward pressure on interest rates, thereby lowering consumer spending and business investment.

Detailed explanation-5: -The initial change in spending times the spending multiplier gives you the maximum change in GDP (5 x $1000 = $5000). The original $1000 increase in government spending can increase GDP by a maximum of $5000 with an MPC of . 8. Note: The multiplier works the same in reverse.