Question

Below, you are provided with the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves. You will use this information to identify the economy is experiencing a recessionary gap or an expansionary gap. You will then determine whether expansionary or contractionary monetary policy is more desirable. 140 Price Level 138 LAS 136 SAS 134 X 132 130 AD 128 300 350 400 450 500 550 600 Real GDP (in billions) Part 1: Identify the value of Potential GDP in the economy depicted above. Part 2: Identify the value of Real GDP in the economy depicted above. Part 3: Based on your answers to Part 1 and Part 2, is the economy depicted above experiencing a recessionary or an expansionary gap?

Answer 1

Part 1: The value of potential GDP = 425 billions

Explanation:

The potential GDP refers to the value of highest level of output ( goods and services) that a country can produce with the existing resources. It is a related to the long run. It is also known as full employment level of GDP.

Part 2: The value of real GDP = 400 billions

The real GDP refers to the value of current or actual level of output ( goods and services) that a country is producing . It is related to the short run.

Part 3: The economy is experiencing a contractionary gap.

Explanation:

When , the real GDP <  the potential GDP , then there will be a contractionary gap in the economy.

When , the real GDP > the potential GDP , then there will be an expanssionary gap in the economy.

Part 4: An expansionary monetary policy would be more desirable.

Explanation:

The Federal Reserve shoul adopt an expansionary monetary policy to control recession by injecting more money supply in the economy.

Part 5: The Federal Reserve should conduct open market purchases.

Part 6 : The Federal Reserve should lower the reserve requirement.

Explanation:

Under an expansionary monetary policy , the Federal Reserve conduct open market purchases and lower the reserve requirement in order to inject more money supply in the economy.