8. Refer to the figure below for the following set of questions. The dotted line

Question

8. Refer to the figure below for the following set of questions. The dotted line it the potential GDP, Y*. Long-term Growth Trend and Business Fluctuations Real GDP (1996 dollars,billions) a) If we are at point C, what would be appropriate Keynesian policy for the government, expansion or contraction? b) Explain the above and be concrete. c) indicate on the graph which interval(s) indicate a recession (must identify all intervals if more than one)? d) Indicate on the graph which interval(s) represent(s) the existence of negative cyclical unemployment (a positive output gap)?

Explanation / Answer

a. At point C, there should be expansionary fiscal policy by the government.

b. This is because, C is a point of recession where demand is low. In order to boost aggregate demand, Government should spend more in order to increase aggregate demand through the multiplier effect.

c. (B to C) and (D to E) are intervals of recession

d. Part of B and D lying above dotted line represents positive output gap.

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