Which of the following statements is true? An increase in government purchases b

Question

Which of the following statements is true?

An increase in government purchases by $10 million will cause real GDP to increase by exactly $10 million.

Consumption, investment, and net export spending are all likely to change as a result of a change in government purchases.

Most conditional forecasts assume that a change in government purchases has no effect on the other spending components of real GDP.

Only consumption spending is affected by changes in government purchases.

A change in government purchases has no effect on the other spending components of real GDP.

Explanation / Answer

Option (2) is correct.

When government purchases change, it leads to a more-than-proportionate change in real GDP (through multiplier effect) and income, which in turn changes consumption demand (a direct change), investment demand (a direct change) and import demand a direct change - as a result of which, Net exports (= exports - Imports) change in opposite direction of the change in real GDP.

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