Question

1. Suppose that the government purchases multiplier equals 2. Real GDP is $14 trillion and potential real GDP is $14.5 trillion.

Is there a recessionary output gap or a contractionary output gap?

2. In order to close this output gap, the government purchases would need to_____:

incease, decrease, stay the same?

3. and lastly, calculate by how much exactly government purchases have to increase (or decrease)

A                                                                                                                           

Answer 1

Solution-

1. Is there a recessionary output gap or a contractionary output gap?

Yes, It is a Recessionary gap because, Real GDP is less than Potential real GDP.

2. In order to close this output gap, the government purchases would need to Increase.

Reason-

The government purchases would need to increase because, it is a recessionary gap to balance this gap government purchases would need to increase.

3. how much exactly government purchases have to increase?

Change in Government purchases = Recessionary Gap / Multiplier

Recessionary Gap = Potential GDP - Real GDP

= 14.5 - 14

= 0.5 trillion. or 500 billion

.Change in GP = 0.5 / 2 = 0.25 trillion or 250 billion.

Therefore, Government purchases have to incresed by $0.25 trillion or $250 billion.