Which of the following will most likely result from a decrease in government spending?

• A. A decrease in aggregate demand
• B. An increase in real GDP
• C. A rise in unemployment
• D. An increase in inflation

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the role of government spending in the economy. Government spending is a component of aggregate demand (AD), which is the total demand for goods and services in an economy at a given overall price level and in a given period.
2. Step 2: Recall the aggregate demand formula: \(AD = C + I + G + (X - M)\), where \(C\) is consumption, \(I\) is investment, \(G\) is government spending, and \((X - M)\) is net exports. A decrease in government spending (\(G\)) directly reduces aggregate demand.
3. Step 3: Analyze the effect of a decrease in aggregate demand. When aggregate demand decreases, the overall demand for goods and services falls, which tends to reduce real GDP in the short run because firms produce less to meet lower demand.
4. Step 4: Consider the impact on unemployment. Lower real GDP typically means less production, which can lead to layoffs or slower hiring, causing unemployment to rise.
5. Step 5: Evaluate the effect on inflation. A decrease in aggregate demand usually puts downward pressure on prices, reducing inflation or causing deflation, rather than increasing inflation.