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Chapter 11: Q9. (page 236)

Question: If an economy has an inflationary expenditure gap, the government could attempt to bring the economy back toward the full-employment level of GDP by _______ taxes or _______ government expenditures.

  1. increasing; increasing

  2. increasing; decreasing

  3. decreasing; increasing

  4. decreasing; decreasing

Short Answer

Expert verified

Option (b) increasing; decreasing

Step by step solution

01

Step 1. Concept of inflationary gap

Inflationary expenditure gap occurs when the equilibrium GDP exceeds full-employment GDP. This gap occurs due to demand-pull inflation.

At full employment, only the price level increase because the output has already reached its total capacity. Beyond the potential GDP, resources cannot be employed. Thus, a high demand pulls the prices up, and equilibrium GDP moves beyond potential GDP.

02

Step 2. Explanation for the correct option

Demand-pull inflation needs to be controlled to reduce the inflationary gap so that prices and equilibrium GDP decrease.A higher full employment level is the result of an excess of total spending. To control the total spending, the government has to apply the contractionary fiscal policy.The contractionary fiscal policy means an increase in taxes and a reduction in government expenditure.

High taxes will reduce the disposable income and thus the consumption expenditure. Simultaneously, a reduction in government expenditure will directly reduce the total spending in the economy. Therefore, the demand and prices will decrease, and excess GDP will be restored to full employment level.

Thus, the government can increase taxes or decrease government expenditure to reduce the inflationary expenditure gap.

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Most popular questions from this chapter

Using the consumption and saving data in problem 1 and assuming investment is \(16 billion, what are saving and planned investment at the \)380 billion level of domestic output? What are saving and actual investment at that level? What are saving and planned investments at the \(300 billion level of domestic output? What are the levels of saving and actual investment? In which direction and by what amount will unplanned investment change as the economy moves from the \)380 billion level of GDP to the equilibrium level of real GDP? From the \(300 billion level of real GDP to the equilibrium level of GDP?

Possible Levels of Employment, Millions

Real Domestic Output (GDP = DI), Billions

Consumption, Billions

Saving, Billions (DI 鈥� C)

40

\)240

\(244

-\)4

45

260

260

0

50

280

276

4

55

300

292

8

60

320

308

12

65

340

324

16

70

360

340

20

75

380

356

24

80

400

372

28

Assume that, without taxes, the consumption schedule of an economy is as follows.

GDP, Billions

Consumption, Billions

\(100

\)120

200

200

300

280

400

360

500

440

600

520

700

600

  1. Graph this consumption schedule and determine the MPC.

  2. Assume now that a lumpsum tax is imposed such that the government collects $10 billion in taxes at all levels of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.

The economy鈥檚 current level of equilibrium GDP is \(780 billion. The full-employment level of GDP is \)800 billion. The multiplier is 4. Given those facts, we know that the economy faces _______ expenditure gap of ___________.

  1. an inflationary; \(5 billion

  2. an inflationary; \)10 billion

  3. an inflationary; \(20 billion

  4. a recessionary; \)5 billion

  5. a recessionary; \(10 billion

  6. a recessionary; \)20 billion

Refer to the accompanying table in answering the questions that follow:

(1) Possible Levels of Employment, Millions

(2) Real Domestic Output, Millions

(3) Aggregate Expenditures (Ca + Ig+ Xn+ G), Millions

90

\(500

\)520

100

550

560

110

600

600

120

650

640

130

700

680

  1. If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap? What will be the consequence of this gap? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or the recessionary expenditure gap? What is the multiplier in this example?

  2. Will there be an inflationary expenditure gap or a recessionary expenditure gap if the full employment level of output is $500 billion? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example?

  3. Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the values of the MPC, the MPS, and the multiplier?

A depression abroad will tend to _______ our exports, which in turn will _______ net exports, which in turn will ______ equilibrium real GDP.

  1. reduce; reduce; reduce

  2. increase; increase; increase

  3. reduce; increase; increase

  4. increase; reduce; reduce
See all solutions

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