Question

If there is initially a federal budget deficit, and taxes fall while transfer payments rise:

A. there is an indeterminate effect on both AD and the budget deficit.
B. AD increases and the budget deficit increases.
C. AD increases and the budget deficit decreases.
D. AD decreases and the budget deficit increases.
E. AD decreases and the budget deficit decreases.

Answer 1

If taxes fall while transfer payments rise and there is initially a federal budget deficit, the effect on both AD and the budget deficit is indeterminate.

Step-by-step explanation:

If there is initially a federal budget deficit, and taxes fall while transfer payments rise, the effect on both AD and the budget deficit is indeterminate. This is because the change in taxes and transfer payments can have different impacts on aggregate demand and the budget deficit depending on other factors. For example, if the decrease in taxes leads to increased consumer spending, it could stimulate aggregate demand. However, if the increase in transfer payments leads to increased government spending, it could offset the positive impact of the tax cut.