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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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