Question 1
10 pts
(03.01-03.09 HC)
For all graphs, be sure to correctly and completely label all axes and curves and use arrows to indicate the direction of any shifts.
The United States is currently experiencing an inflationary gap.
a. Draw a correctly labeled graph of the aggregate demand, long-run aggregate supply, and short-run aggregate supply curves.
i. Label the equilibrium price level PL and the equilibrium real output Y.
ii. Label the full-employment level of output YF.
b. What can be assumed about the actual rate of unemployment compared to the natural rate of unemployment, based on the information above? Explain.
c. Assume that the output gap is estimated to be $800 billion and the federal government decides to take action. If the marginal propensity to consume is 0.8, by how much would it need to change government spending to close the gap? Show your work and indicate whether the change would be a spending increase or decrease.
d. An alternative bill in Congress proposes to use the income tax to close the output gap rather than changes in spending. Calculate the change in tax revenue the government would need to close the gap. Assume the same figures as part (c).
e. What is one possible automatic stabilizer in the economy that would contribute to closing this?
f. Assume that instead of intervening, the government allowed the economy to self-adjust in the long run. On your graph from part (a), illustrate how the economy would self-adjust in the long run.
g. If the GDP deflator is 140 in the year that the inflationary gap is identified, and three years later it is 140, does this mean that there has been inflation over the three years? Explain.
h. After the long-run adjustment in part (f), is the economy operating inside or outside of its production possibilities curve?
