Question

When taxes are cut, real GDP ____ and the price level ____.

	1) increases; rises
	2) increases; falls
	3) decreases; rises
	4) decreases; falls

Answer 1

Answer is : increases ; rises.

Explanation

Tax changes that are made to promote long-run growth, or to reduce an inherited budget deficit, in contrast, are undertaken for reasons essentially unrelated to other factors influencing output. Thus, examining the behaviour of output following these relatively exogenous tax changes is likely to provide more reliable estimates of the output effects of tax changes. The results of this more reliable test indicate that tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent. So in the same way if taxes are reduced the real GDP increases.

That the increased spending affected real GDP and employment was a by-product. The effect of such changes on real GDP and the price level is secondary, but not being ignored. Discretionary fiscal policy that is undertaken with the intention of stabilizing the economy.

Discretionary government spending and tax policies can be used to shift aggregate demand. Expansionary fiscal policy might consist of an increase in government purchases or transfer payments, a reduction in taxes, or a combination of these tools to shift the aggregate demand curve to the right. A contractionary fiscal policy might involve a reduction in government purchases or transfer payments, an increase in taxes, or a mix of all three to shift the aggregate demand curve to the left.