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Chapter 13: Q. 10 (page 297)

Consider the accompanying diagram, in which the current short-run equilibrium is at point A, and answer the questions that follow:

a. What type of gap exists at point A?

b. If the marginal propensity to consume equals 0.75, what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

Short Answer

Expert verified

a) The type of gap exists at the point is determined as inflationary gap

b) The changes in government spending reduced is found as$0.20trillion

Step by step solution

01

Introduction 

The given is the current short equilibrium at a point

The objective is to determine the type of gap and the changes in the expenses of the government

02

Explanation (part a)

a)

Since the current equilibrium at A, where real GDP is $18.8trillion and potential GDP is $18 trillion, This suggests that there is an inflationary gap.

03

Explanation (part b)

b)

The $0.8trillion budget deficit must be closed by reducing government spending. The multiplier is four times the value of MPS ($0.25).

As a result, a $0.20 trillion cut in spending is required.

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