Question

Suppose the economy is operating at an output level of $5,400 billion. Assume furthermore that potential output is $5,000. Which would be necessary to close this inflationary gap if the marginal propensity to consume is 0.75?

Answer 1

The government should decrease spending by $100 billion.

Step-by-step explanation:

The potential output level of an economy is $5,000 billion.

The economy is operating at an output level of $5,400 billion.

We see that there is an inflationary gap of $400 billion as the economy is operating at an output level of $400 billion more than the potential output level.

The marginal propensity to consume is 0.75.

ΔY =
`(1)/(1 - MPC)\ *\ \Delta G`

$400 billion =
`(1)/(1 - 0.75)\ *\ \Delta G`

ΔG =
`(400)/(4)`

ΔG = $100 billion