A decrease in government spending will cause a(n):

• A. increase in inflation
• B. increase in unemployment
• C. increase in aggregate supply
• D. decrease in aggregate demand

Answer: (D)

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 \(G\) directly reduces aggregate demand.
3. Step 3: Analyze the effects of a decrease in aggregate demand. When aggregate demand decreases, there is less overall spending in the economy, which tends to reduce output and increase unemployment in the short run.
4. Step 4: Consider the impact on inflation. A decrease in aggregate demand typically leads to lower price levels or lower inflation because demand pressures on prices weaken.
5. Step 5: Differentiate aggregate demand from aggregate supply. A change in government spending affects aggregate demand, not aggregate supply, so a decrease in government spending does not cause an increase in aggregate supply.