Question

1. The hypothetical information in the following table shows what the values for real GDP and the price level will be in 2015 if the government does not use fiscal policy :

Year	Potential GDP	Real GDP	Price Level
2014	$1.50 trillion	$1.50 trillion	110.0
2015	$1.54 trillion	$1.50 trillion	111.5

1. If Parliament wants to keep real GDP at its potential level in 2015, should it use an expansionary policy or a contractionary policy? Explain whether the government should be increasing or decreasing government purchases or taxes.
2. If Parliament is successful in keeping real GDP at its potential level in 2015, state whether each of the following will be higher or lower than if they had taken no action:
3. Real GDP
4. Potential real GDP
5. The inflation rate
6. The unemployment rate

Answer 1

a) As real GDP in 2015 is less than its potential GDP, government should adopt expansionary fiscal policy or monetary policy to raise aggregate demand in an economy which will raise level of real GDP. Government should increase their purchases and lower their taxes such that people have more money to spend on goods and services which will raise aggregate demand.

b) If parliament is able to increase its real GDP to potential level:

c) Real GDP will increase

d) Potential real GDP will remain same

e) Inflation rate will also rise because there will be rise in willingness to pay by consumers and they are willing to pay higher price for the same good.

f) Unemployment rate is likely to fall because real GDP will rise.