3. The accompanying diagram shows the current macroeconomic situation for the ec

Question

3. The accompanying diagram shows the current macroeconomic situation for the economy of Econoland; the actual real GDP is Yi, and the aggregate price level is Pt. You have been hired as an economic consultant to help the economy move to potential output, Yp Aggregate LRAS SRAS AD Real GDP PotentialPY output 3a. Which type of fiscal policy-expansionary or contractionary-would move the economy of Econoland to potential output, Yp? What are some examples of such policies? 3b. Illustrate in the following diagram the macroeconomic situation in Econoland after the successful fiscal policy has been implemented. Aggregate price level LRAS SRAS AD1 Potential Y output Real GDP

Explanation / Answer

Answer:- 3(a) Contractionary fiscal policy would move the economy of Econoland to potential output Yp. For example- The government can reduces its expenditures or it can reduce the tax so that the AD curve will shifts towards left and the economy would be in long run equilibrium.

3(b). So implementing contractionary fiscal policy successfully then the AD1 curve shift towards left and cut where LRAS and SRAS curve intersect. Therefore the economy of Econoland would move to potential output Yp. Just draw the AD1 curve parallel towards left.

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