Question

Question text

You are an economic adviser to the President. Currently the price level of 115 exceeds the expected price level of 110 in the economy. The real GDP at $19.2 trillion exceeds potential output (real GDP) of $19.0 trillion. Both you and the President are concerned with the higher price level and potential future inflation. You recognize you have an "expansionary" gap. Further you both recognize that unemployment is low, (below its natural rate). You recommend an "active" approach to close the expansionary gap and advocate that the President raise taxes or reduce government spending. The President indicates reducing government spending is nearly impossible for various reasons with which you agree. **However, the President is also fearful of raising taxes "politically", as an election is upcoming. **The President goes against your advice and elects a"passive" (market) approach whereby no action is taken and market forces work to close the gap.

Identify the accurate statement or statements below:

Select one:

a. using the passive approach results in higher negotiated wages and costs, and as a result a higher price level than the current level of 115

b. using the passive approach results in lower output (real GDP)

c. using the passive approach results in lower employment (higher unemployment)

d. using the passive approach results in higher employment (lower unemployment)

e. a, b, and c. are accurate

f. a, b, and c. are accurate

Answer 1

The passive approach will lead to inflation as market forces themselves orient towards equilibrium output. Thus the price level will increase as inflation is high, workers will ask for higher remuneration and salary as prices of goods are high. This will lead to firm's factor of production cost increasing which will lead to lesser hiring and it will reduce the real GDP.

Thus a. b. and c. are the accurate statements as price level will increase because of higher negotiation in wages, the real output reduces and employment reduces.