Given the following table. Now assume that full employment is at a real GDP of 3
ID: 1196272 • Letter: G
Question
Given the following table.
Now assume that full employment is at a real GDP of 300.
17. At 300, what will occur?
18. At 360, what will occur?
19. If the government increased taxes when the economy is operating at 300, what will occur?
20. If the government increased taxes on households, what will occur?
21. For the economy described in the table, what spending sectors are not included?
22. For the economy described in the table above, assume a full employment GDP of 360. What is the appropriate government policy to achieve full employment?
Government
Spending
(Billions)
Real domestic
output (GDP)
(billions)
Consumption
(billions)
Taxes
(Billions)
Investment
(billions)
Aggregate Expenditures
(billions)
$4
4
4
4
4
4
4
4
4
$240
260
280
300
320
340
360
380
400
$240
256
272
288
304
320
336
352
368
$ 5
5
5
5
5
5
5
5
5
$16
16
16
16
16
16
16
16
16
$260
276
292
308
324
340
356
372
388
Government
Spending
(Billions)
Real domestic
output (GDP)
(billions)
Consumption
(billions)
Taxes
(Billions)
Investment
(billions)
Aggregate Expenditures
(billions)
$4
4
4
4
4
4
4
4
4
$240
260
280
300
320
340
360
380
400
$240
256
272
288
304
320
336
352
368
$ 5
5
5
5
5
5
5
5
5
$16
16
16
16
16
16
16
16
16
$260
276
292
308
324
340
356
372
388
Explanation / Answer
(17) When real GDP = 300 (full employment), aggregate expenditure = 308
Or, Actual output is higher than potential output by (308 - 300) = 8 billion. This creates a positive output gap resulting in inflation.
(18) When real GDP = 360, aggregate expenditure = 356
Or, Actual output is lower than potential output by (360 - 356) = 4 billion. This creates a negative output gap or deflation.
(19) When GDP = 300, increase in taxes will lower disposable income which will reduce aggregate demand. This will lower the positive output gap and may eliminate this gap based on how much the tax changes.
(20) In general, higher tax on household will lower household disposable income and consumption demand will decrease, resulting in a reduction in aggregate demand.
(21) Y = C + I + G + X - M
So, export & imports (foreign trade sector) are excluded.
(22) When full employment GDP is 360, aggregate expenditure is 356, resulting in a negative output (recessionary) gap of 4 billion. This gap can be closed by a cut in taxes (which boosts disposable income & consumption, raising aggregate demand) and/or a higher government spending (which increases aggregate demand). Such policy is called expansionary fiscal policy.
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