Question

OOOO 67 38 OOOO 68 39 OOOOO 69 DO 40 OOOO DOO 41 OD OD 42 13 ODOO 43 OOOO 44 D OOO OOOO OOO 92 OOOOO 93 OOOOO 94 OOOOO 95 Short Answer (5 points) a) If an economy is experiencing a recessionary and the government wishes to use fiscal policy to close this gap by changing the position of the aggregate demand curve, what are its two options (be specific)? OO OO 0 131 132 139 134 135 b) If it chooses to use one of these two options, what will happen to production, employment, and the price level? c) If the government wants to close the gap by changing the position of the ageregate supply curve, what can it do (be specific)? d) What will happen to production, employment, and the price level in this case? e) If you were a policy-maker and constrained to using only fiscal policy), what would you recommend and why?

Answer 1

a) Recessionary gap is the difference between the real GDP and the potential GDP.This is also referred as contractionary gap.There is increase in unemployment,decrease in production and lower economic growth.The fiscal policy implemented is the reduction of taxes and increasing the government spending in order to boost demand.

b)If the government uses the expansionary fiscal policy ,demand will increase ,and AD curve will shift to the right.Unemployment will decrease as government spending increases,production will increase and price level will go up.Thus increase in government spending will increase AD, leading to a higher output ,higher employment and higher price level.

c) To control recession the FED uses expansionary policy to increase the money supply and thus increase the quantity of loans,reduce interest rate .When interest rate is low ,borrowing money is cheap and banks are willing to lend money.

d)When Fed increases the money supply the value of money falls and price level increases.national output will be less and unemploynent will be low.

e)My recommendation is that I would allow federal debt to rise as a percentage of GDP.increase federal investment and pay for that increase with cuts in benefits for higher income retirees,and increase tax revenue.Doing these , debt will decline relative to GDP in the long run.

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