Question

How is the full employment level of real GDP determined? Assume expansionary fiscal or monetary policy is undertaken when the economy is at full employment. Does the outcome differ from what would have occurred had the economy not been at full employment (explain why or why not)?

Answer 1

The full employment level is determined by the presence of frictional unemployment and structural unemployment. At a full employment level of real GDP, economy will have natural rate of unemployment that will be the sum of frictional unemployment and structural unemployment. So, an economy exhibiting a level of unemployment, will be the sum of frictional and structural unemployment and it is determined as the full employment situation at a real GDP.
When expansionary monetary or fiscal policy is taken when economy is at full employment, then it will differ in impact in short run in comparison to the expansionary monetary or fiscal policy is taken when economy is below full employment. Though the long run impact will be same.
When economy is full employment, then use of expansionary policy, will create inflationary gap in the short run, creating demand pull inflation and SRAS shifting to the left and achieve full employment in the long run. Though it will come at a higher price. When expansionary policy, will be used in an economy below full employment, then AD will shift to the right and economy will be at full employment in the long run.
It happens because output is a real variable that does not change, but price is nominal variable and it changes.