When a government increases transfer payments such as unemployment benefits, the most likely effect on aggregate demand is
Question 1 Report
When a government increases transfer payments such as unemployment benefits, the most likely effect on aggregate demand is
Answer Details
The correct answer is an increase because recipients spend a large proportion of the additional income.
Transfer payments such as unemployment benefits put money directly into the hands of low-income recipients who have a high marginal propensity to consume. They tend to spend most of the additional income on goods and services, which increases consumer spending and therefore raises aggregate demand.
While transfer payments are not direct government purchases of goods and services, they still boost AD by increasing household spending. The payments are not automatically offset by higher taxes. Government borrowing to fund transfers may have long-run consequences, but the short-run effect on AD is an increase, not a decrease.
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