Consider a hypothetical economy in which the marginal propensity to consume (MPC

Question

Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.5. The following graph shows the aggregate demand curves (AD_1 and AD_2), the short-run aggregate supply curve (SRAS), and the long-run aggreate supply curve (LRAS). The economy is currently at and the long-run point A. The economy is currently experiencing gap of billion. In order to close this gap, one option would be for the government to government purchases by billion (assuming net taxes do not change). If the government kept its purchases constant, it could also close the gap by net taxes by billion.

Explanation / Answer

Aggregate Demand increases led to shift in AD curve thereby increasing prices and GDP

inflationary gap of 100 billion.

decrease government purchase by 100 b

raising net taxes by 100 b

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