Refer to the table below in answering the questions that follow: If full employm

Question

Refer to the table below in answering the questions that follow: If full employment in this economy is 130 million, will there be an inflationary gap or a recessionary gap? BY how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example? Will there be an inflationary or a recessionary gap if the full-employment level of output is $500billion? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? What is the multiplier in this example?

Explanation / Answer

1. Full employment = $130 million

Equilibrium GDP = $600 billion

Full employment GDP = $700 billion

Thus, the employment will be $20 million less at full employment. The aggregate expenditures would have to increase by $ 20 billion ($700 billion - $680 billion) at each level of GDP to eliminate the recessionary gap. A recessionary gp exists when full employment GDP is greater than the real GDP. Thus, in this case, it is a recessionary gap.

MPC = Change in Consumption/ Change in Income = $40 billion/$50 billion = 0.8

MPS = 1 - MPC = 1 - 0.8 = 0.2

Thus, Multiplier (K) = 1/ 1 - MPC = 1/ 1 - 0.8 = 5

2. If full employment level of output is $500 billion, then there is excess of aggregate expenditure. Therefore, aggregate expenditure would have to decrease by $20 billion ($520 billion - $500 billion) at each level of GDP to eliminate the inflationary gap. An inflationary gap exists when full employment GDP is less than the real GDP. Thus, in this case, it is an inflationary gap. In this case, the multiplier = 5, it remains the same as multiplier is not affected by the level of full employment GDP.

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