Question

If the federal government attempts to eliminate a budget deficit during a depression, this will (LO4) a) alleviate the depression b) contribute to inflation c) make the depression worse d) have no economic effect

Short answer

The correct answer is (c) make the depression worse. Attempting to eliminate a budget deficit during a depression can lead to higher taxes and reduced public spending, which may result in decreased consumer spending and economic growth, worsening the depression.

Step-by-step solution

Understand Key Terms

It is essential to understand the key terms to answer this question correctly. Budget deficit refers to a situation when the government's expenses exceed its revenue. A depression is a severe and prolonged downturn in the economy, characterized by high unemployment, low production, and reduced consumer spending.

Analyze the Given Options

Let's analyze each of the given options one by one: a) Alleviate the depression: If the government tries to eliminate the deficit during a depression, it would mean either increasing revenues (e.g., raising taxes) or cutting expenses (e.g., cutting public spending). In a depression, raising taxes may further decrease consumer spending, while cutting public spending may lead to lower economic growth. Hence, it may not alleviate the depression. b) Contribute to inflation: Inflation refers to a sustained increase in the overall price level. Eliminating a deficit during a depression would involve actions that do not increase the money supply in the economy. Therefore, attempting to eliminate the deficit during a depression is not likely to contribute to inflation. c) Make the depression worse: As mentioned earlier, attempting to eliminate the deficit could lead to higher taxes and reduced public spending, which in turn decreases consumer spending and economic growth. Therefore, the depression may become worse. d) Have no economic effect: It is unlikely that the government's actions would have no economic effect, as this contradicts the fundamental concepts of fiscal policy and its impact on an economy.

Identify the Correct Option

Based on our analysis, the correct option is (c) make the depression worse. Attempting to eliminate a budget deficit during a depression can lead to lower consumer spending and economic growth, which may worsen the depression.

Key concepts

Fiscal Policy

Fiscal policy refers to the government's use of taxation and spending to influence the economy. During hard times like a depression, the government may change its fiscal policy to help the economy recover. It often includes boosting spending on public projects, providing tax cuts, or both, to put more money in people's hands.

• Increases in government spending can create jobs and stimulate more economic activity.
• Tax cuts boost the disposable income of individuals, encouraging consumer spending.

By carefully adjusting taxes and spending, the government influences the economic cycle. In a depression, a stricter fiscal policy focused on cutting deficit could backfire by slowing economic recovery.

Economic Depression

An economic depression is an extreme downturn in economic activity. It impacts many factors, including employment, consumer income, and overall productivity.

• Characterized by a significant decline in GDP.
• Features high levels of unemployment, leading to less consumer spending.
• Businesses slow down, and production levels drop.

Understanding a depression's severity helps frame the impacts of different economic measures. Interrupting a depression without supportive fiscal policies can worsen the cycle by reducing demand and investment.

Consumer Spending

Consumer spending is the total money spent by consumers on goods and services. It plays a crucial role in a country's economic health. During a depression, consumer spending typically plummets, as people save more or face unemployment.
To spark economic recovery, policies that increase consumer spending are vital. These can include government financial stimulus directly to families or tax rebates.

• Increases demand for goods and services.
• Encourages businesses to hire more workers, reducing unemployment.

Higher taxes or reduced government spending can lead to a decrease in disposal income, thus further reducing consumer spending.

Government Spending

Government spending involves all expenditures incurred by the government in its activities to influence the economy. During a depression, increasing government spending can be a tool to spark economic revival.

• Investment in infrastructure can create employment opportunities.
• Public services like education and healthcare can receive additional funding, benefiting society at large.

Lowering government spending during a depression, in an attempt to eliminate budget deficits, may result in adverse effects, as less money circulates in the economy, leading to lower demand and prolonged recession.