Question

Quantitative Reasoning Assignment on Fiscal Policy Assume the economy is currently in short run equilibrium but...

Quantitative Reasoning Assignment on Fiscal Policy

  1. Assume the economy is currently in short run equilibrium but experiencing a recessionary gap, what combination of fiscal policies might the Federal government pursue to correct problem? Graphically illustrate and explain.
  2. Assume the economy is currently in short run equilibrium but experiencing an inflationary gap, what combination of fiscal policies might the Federal government pursue to correct problem? Graphically illustrate and explain.

Homework Answers

Answer #1

In each graph, initial long-run equilibrium is at point A where initial aggregate demand (AD0) intersects initial short-run aggregate supply curve (SRAS0) and long-run aggregate supply curve (LRAS0), with long-run equilibrium price level P0 and real GDP (potential GDP) Y0.

(1)

A recessionary gap arises when aggregate demand falls, shifting AD curve leftward, decreasing both price level and real GDP. In this case government pursues expansionary fiscal policy, by increasing government spending and/or by decreasing taxes, to increase real GDP and pull the economy out of recession.

In following graph, with recession, position of economy is at point B where aggregate demand is lower at AD1 which intersects SRAS0 with lower price level P1 and lower real GDP Y1. Recessionary gap is (Y0 - Y1). When government spending rises or tax falls, aggregate demand rises and AD1 shifts rightward to AD0, eliminating recessionary gap.

(2)

An inflationary gap arises when aggregate demand rises, shifting AD curve rightward, increasing both price level and real GDP. In this case government pursues contractionary fiscal policy, by decreasing government spending and/or by increasing taxes, to decrease real GDP and ease out the inflationary pressure.

In following graph, with expansion, position of economy is at point B where aggregate demand is higher at AD1 which intersects SRAS0 with higher price level P1 and higher real GDP Y1. Expansionary gap is (Y1 - Y0). When government spending falls or tax rises, aggregate demand falls and AD1 shifts leftward to AD0, eliminating expansionary gap.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
An economy is in long-run macroeconomic equilibrium, with output at Yp, when the following aggregate demand...
An economy is in long-run macroeconomic equilibrium, with output at Yp, when the following aggregate demand shock occurs: The quantity of money in the economy declines and interest rates increase. What kind of gap (inflationary or recessionary) will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output? This will cause an inflationary gap; an expansionary policy should be used. This will cause a recessionary gap; an expansionary policy...
Assume that there are two economies, A and B. Economy A is experiencing an inflationary output...
Assume that there are two economies, A and B. Economy A is experiencing an inflationary output gap, and economy B is experiencing a recessionary output gap. Illustrate the two economies in labeled graphs. Explain what will happen to wages and other factor prices in economy A and if this will increase or decrease firm's unit cost. Given your answer in (b) show the effects on the AS curve. Explain what happens to real GDP and the price level. Explain what...
In macro short run equilibrium Economy is in a recessionary period Economy is in an inflationary...
In macro short run equilibrium Economy is in a recessionary period Economy is in an inflationary period Either recessionary or inflationary period Not enough information Which of the following would lead to change in Investment ? Current level of income Change in expenditure Change in the interest rate All of the above.
assume the economy is currently experiencing an inflationary gap or expansion . using a graph explain...
assume the economy is currently experiencing an inflationary gap or expansion . using a graph explain how econmy can return to full employment in the long run without any government inventions
Please, draw Aggregate Demand, Short Run Aggregate Supply, and Long Run Aggregate Supply as if an...
Please, draw Aggregate Demand, Short Run Aggregate Supply, and Long Run Aggregate Supply as if an economy is in both short run and long run equilibrium. Now, Suppose the price of oil (an input in the production of many goods) decreases. Can you please Show how this will affect the model starting from (1) above. What happens to GDP, The Price Level, and Potential Output? Is the economy in a recessionary gap or an inflationary gap? Also, Suppose that consumers...
What is expansionary fiscal policy? What gap is the economy experiencing when expansionary fiscal policy is...
What is expansionary fiscal policy? What gap is the economy experiencing when expansionary fiscal policy is used? What is contractionary fiscal policy? What gap is the economy experiencing when contractionary fiscal policy is used? What type of fiscal policy (expansionary or contractionary) do you think the President and Congress are currently enacting? Explain your reasoning.
For this assignment you will need to view the economy as a whole (aggregate) and not...
For this assignment you will need to view the economy as a whole (aggregate) and not from your own industry. Assuming our economy is experiencing unemployment of 7.5% and people are generally feeling good about the economy. According to Keynesian theory, what could happen in our economy to create a recessionary gap? The second part of the assignment is to explain one thing our government could do to recover or correct that recessionary gap?
Assume that the US economy is in equilibrium. Now assume that C & Ig decrease because...
Assume that the US economy is in equilibrium. Now assume that C & Ig decrease because of a drop in consumer and business confidence. Using an AD/AS graph, show the economy in equilibrium and then what happens when confidence drops. Explain the situation the US economy is facing (i.e., a recession) both graphically and in words (hint would you more likely have a deflationary or an inflationary gap in a recession?). Then explain the two options available, both fiscal policy...
Is a recessionary or inflationary gap bad for an economy? Have you ever wondered how the...
Is a recessionary or inflationary gap bad for an economy? Have you ever wondered how the federal government and the Federal Reserve react to smooth out recessionary and inflationary gaps? In this activity, you will explore the concepts of fiscal policy and the attempts the U.S. government takes when the U.S. economy is in a recessionary or inflation gap. You will discuss the concepts of aggregate supply and aggregate demand to determine how the U.S. economy can work its way...
Draw an economy in long run equilibrium. b) Suppose that the U.S. dollar depreciates. Which curve...
Draw an economy in long run equilibrium. b) Suppose that the U.S. dollar depreciates. Which curve will shift as a result of the shock? c) Illustrate the shift on your graph above. d) Explain what happens to Y, P, and unemployment in the short-run. e) State whether the economy is at a full-employment equilibrium, below full-employment equilibrium, or above full- employment equilibrium after the shock. Principles of Macroeconomics f) State whether the unemployment rate is above or below the Natural...