Question

How would the government most likely respond to a decrease in consumer spending?

A. By raising interest rates

B. By decreasing the money supply

C. By adding to its discretionary spending budget

D. By raising income taxes

Answer 1

The correct answer is C.

A decrease in consumer spending means a decrease in the aggregate demand levels and, in consequence, in total output and in the employment figures. Therefore, the economy is experiencing a contraction.

In order to reverse the trend, a discretionary spending budget can be implemented. Investing public money would boost aggregate demand levels and create job positions. These new workers will start to earn a salary, increase their income available and start to demand more goods and service, therefore expanding aggregate demand even further. Therefore, the economy will start to grow again.