Question

Refer to the table given below. Suppose that aggregate demand increases such that the amount of real output demanded rises by $7 billion at each price level.

Real Output Demanded (Original)	Price Level	Real Output Supplied
$506	116	$513
508	108	512
510	100	510
512	92	507
514	84	502

a. By what percentage will the price level increase?

percent

b. Will this inflation be demand-pull inflation or will it be cost-push inflation?

(Click to select)Demand-pull inflationCost-push inflation

c. If potential real GDP (that is, full-employment GDP) is $510 billion, what will be the size of the positive GDP gap after the change in aggregate demand?

$ billion

d. If the government wants to use fiscal policy to counter the resulting inflation without changing tax rates, would it increase government spending or decrease it?

(Click to select)DecreaseIncrease

Answer 1

a) Original price level = 100

Real Output demanded	Price level	Real output supplied
513	116	513
515	108	512
517	100	510
519	92	507
521	84	502

New equilibrium price level = 116 (Where demand = supply, equilibrium output = $ 513 bn)

Price level increase = (116 - 100)/100 x 100 = 16%

b) This would be a demand-pull inflation

c) Positive GDP gap = 513 - 510 = $ 3 bn (Equilibrium GDP - potential GDP)

d) The government would decrease government spending to close the positive GDP gap.