Question

1. The information in the table below shows what the situation will be in 2017 if Congress and the President do not use fiscal policy.

Year	Potential GDP	Real GDP	Price Level
2016	$17.5	$17.5	112.8
2017	$18.1	$17.8	114.2

(1) If the Congress and the President want to keep real GDP at its potential level in 2017, should they use an expansionary policy or contractionary policy? In your answer, be sure to explain whether Congress and the President should increase or decrease government purchases and taxes.

(2) If the Congress and the President are successful in keeping real GDP at its potential level in 2017, state whether each of the following will be higher, lower, or the same as it would have been if they had taken no action. (Note: you are comparing the variables at the new equilibrium point with the ones at the old equilibrium point in which the policy hasn’t been implemented.)

(a) Real GDP

(b) Potential GDP

(c) The inflation rate

(d) The unemployment rate

Answer 1

a) If level of GDP is less than level of full employment level of GDP in am economy, there exist recessionary gap in the economy of difference Ql - Qs because Ql shows full employment level of output in the economy while Qs shows real GDP in the economy. To raise output level to Ql from Qs, government should adopt expansionary fiscal policy which will raise government expenditure and reduce tax (which raise disposable income of consumers). These both factors will raise aggregate demand in the economy and shift aggregate demand curve to its right from AD to AD1 which raise the price leve;l from "P" to "P1" and raise output level from "Qs" to "Ql"

b) Real GDP will rise from Qs to Ql

Potential GDP will remain same at Ql

Inflation rate will rise as price rises from P to P1

Unemployment level would fall as more people would be required by producers to produce the higher demand of goods.