Question

In: Economics

o close an inflationary expenditure gap of $20 billion in an economy with a marginal propensity...

o close an inflationary expenditure gap of $20 billion in an economy with a marginal propensity to consume of 0.8, it would be necessary to

decrease the aggregate expenditures schedule by $20 billion.
decrease the aggregate expenditures schedule by $4 billion.
increase the aggregate expenditures schedule by $4 billion.
increase the aggregate expenditures schedule by $20 billion.

Expert Solution

The correct answer is (b) decrease the aggregate expenditures schedule by $4 billion

As there is inflationary gap of 420 billion this means in order to combat this inflationary gap we have to decrease Output by $20 billion so that it can reach potential output(or long run equilibrium)

Formula:

AE(aggregate expenditure) = C + I + G + NX At equilibrium Y = AE

where C = consumption , I = investment , G = Government spending and NX = Net exports.

C = C' + c(Y - T) where C' = autonomous consumption , c = Marginal Propensity to consume = MPC = 0.8

=> Y = C' + 0.8(Y - T) + I + G + NX

=> Y - 0.8Y = C' - 0.8T + I + G + NX

=> Y = (1/0.2)(C' - 0.8T + I + G + NX) = 5(C' - 0.8T + I + G + NX)

Hence,

and =>

Here = Autonomous aggregate expenditure

Hence Aggregate Expenditure schedule or Autonomous Aggregate expenditure should decreased by $4 billion

Hence, the correct answer is (b) decrease the aggregate expenditures schedule by $4 billion

Rahul Sunny answered 2 years ago

how fiscal policy such as changing government expenditure may close recessionary gap/ inflationary gap.

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