The hypothetical information in the following table shows what the situation wil
ID: 1166512 • Letter: T
Question
The hypothetical information in the following table shows what the situation will be in 2015 if the government does not use fiscal policy
Year
Potential Real GDP
Real GDP
Price Level
2014
?$1.52 trillion
? $1.52 trillion
109.0
2015
? $1.571.57
? $1.52 trillion
110.6
a. If Parliament wants to keep real GDP at its potential level in 2015?, it should use
?an expansionary, neither an expansionary nor a contractionary, a contractionary policy.
The government should be?increasing, decreasing (choose one )government purchases? and/or
?increasing, decreasing (choose one) taxes.
b. If Parliament is successful in keeping real GDP at its potential level in 2015?, state whether each of the following will be? higher, lower, or the same as it would have been if they had taken no action. Assume that policy does not affect LRAS.
i. Real GDP will be?(lower than, higher than,the same as) it would have been if Parliament had taken no action.
ii. Potential real GDP will be?(higher than, lower than, the same as) it would have been if Parliament had taken no action.
iii. The inflation rate will be?(higher than, lower than, the same as)it would have been if Parliament had taken no action.
iv. The unemployment rate will be? (the same as, higher than, lower than) it would have been if Parliament had taken no action.
Year
Potential Real GDP
Real GDP
Price Level
2014
?$1.52 trillion
? $1.52 trillion
109.0
2015
? $1.571.57
? $1.52 trillion
110.6
Explanation / Answer
a. In this above scenario we will have potential GDP and real GDP is equal in 2014 but in 2015 real GDP is less than the potential GDP. The price level is also high in 2015. So if parliament wants to keep its real GDP at its potential level in 2015 then - government should use an expansionary policy. The government should be increasing government purchases or decreasing taxes.
b) I. Real GDP will be higher than if it would have been if Parliament had taken no action. It will happen because aggregate demand can push the economy beyond potential level. The rise in aggregate demand will act behind it.
ii) The potential GDP of the economy will be same as it would have been if Parliament had taken no action.
iii) The inflation rate will be higher than it would have been if Parliament had taken no action.
IV) The unemployment rate will be lower than it would have been if Parliament had taken no action. Because according to Phillips curve we know inflation rate and unemployment. Price level will increase and unemployment rate will fall.
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