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Chapter 13: Q. 9 (page 297)

Consider the diagram below, in which the current short-run equilibrium is at point A, and answer the questions that follow.

a. What type of gap exists at point A?

b. If the marginal propensity to save equals 0.02, what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

Short Answer

Expert verified

a) The type of gap that is determined from the level is the recessionary gap

b) The needed amount of spending is determined as $ 0.20 trillion

Step by step solution

01

Introduction

The given is the current short-run equilibrium is at point $A

The objective is to determine the type of gap and the change in government spending

02

Explanation (part a)

a)

Since the current equilibrium at A,

where real GDP is $18trillion and potential GDP is $19trillion,

This indicates that there is a recessionary void.

03

Explanation (part b)

b)

The $1trillion budget deficit must be closed by expanding government spending.

The multiplier is 5when the value of MPS is $0.2.

As a result, $0.20trillion in spending is necessary.

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Most popular questions from this chapter

Discuss ways in which indirect crowding out and direct expenditure offsets can reduce the effectiveness of fiscal policy actions.

Explain how time lags in discretionary fiscal policy making could thwart the efforts of Congress and the president to stabilize real GDP in the face of an economic downturn. Is it possible that these time lags could actually cause the discretionary fiscal policy to destabilize real GDP?

Consider the accompanying diagram, in which the current short-run equilibrium is at point A, and answer the questions that follow:

a. What type of gap exists at point A?

b. If the marginal propensity to consume equals 0.75, what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

Assume that the Ricardian equivalence theorem is not relevant. Explain why an income-tax-rate cut should affect short-run equilibrium real GDP.

Determine whether each of the following is an example of an automatic fiscal stabilizer.

a. A federal agency must extend loans to businesses whenever an economic downturn begins.

b. As the economy heats up, the resulting increase in equilibrium real GDP per year immediately results in higher income tax payments, which dampen consumption spending somewhat.

c. As the economy starts to recover from a severe recession and more people go back to work, government-funded unemployment compensation payments begin to decline.

d. To stem an overheated economy, the president, using special powers granted by Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on govemment programs.
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