50. (Problem 3a) An economy is in long-run macroeconomic equilibrium, with outpu

Question

50. (Problem 3a) An economy is in long-run macroeconomic equilibrium, with output at Yp, when the following aggregate demand shock occurs:

A stock market boom increases the value of stocks held by households.

What kind of gap (inflationary or recessionary) will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output? A. This will cause an recessionary gap; a contractionary policy should be used. B. This will cause an inflationary gap; a contractionary policy should be used. C. This will cause a recessionary gap; an expansionary policy should be used. D. This will cause an inflationary gap; an expansionary policy should be used. 50. (Problem 3a) An economy is in long-run macroeconomic equilibrium, with output at Yp, when the following aggregate demand shock occurs:

A stock market boom increases the value of stocks held by households.

What kind of gap (inflationary or recessionary) will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output? A. This will cause an recessionary gap; a contractionary policy should be used. B. This will cause an inflationary gap; a contractionary policy should be used. C. This will cause a recessionary gap; an expansionary policy should be used. D. This will cause an inflationary gap; an expansionary policy should be used.

Explanation / Answer

Ans:

Option B

This will cause an inflationary gap; a contractionary policy should be used.

The rise in the value of stock held by households will increase consumer spending and this will increase aggregate demand. As a result, economy will face Inflationary gap.Contractionary fiscal policies would move the economy back to potential level of output.

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