Question

FISCAL POLICY

IN-CLASS WORKSHEET 2

This question explores the role of expansionary and contractionary fiscal policy in the Aggregate Demand and Aggregate Supply model. You will use schedules for an aggregate demand line and an aggregate supply line to identify the equilibrium price level and real GDP in a macroeconomy. Additionally, you will compare the short-run equilibrium level of real GDP to the full employment level of real GDP to identify desirable fiscal policies.

Below, you are provided the schedules for an aggregate demand line and an aggregate supply line.

           

Price Level (Consumer Price Index)	Aggregate Demand Real GDP (billions of dollars)	Aggregate Supply Real GDP (billions of dollars)
80	$12	$   4
90	$10	$ 16
100	$ 8	$8
110	$6	$10
120	$4	$12

Task 1: Identify the macroeconomic equilibrium price level in this economy.

Task 2: Identify the macroeconomic equilibrium level of real GDP in this economy.

Task 3: If the full employment level of real GDP is $9 billion, can you discern whether this economy is experiencing an inflationary gap or a recessionary gap?

Task 4: Suppose that the government wants to promote full employment. Should it enact contractionary or expansionary fiscal policy?

Task 5: Suppose that the government wants to promote full employment through the use of taxes. Should it raise or lower taxes? Explain your answer carefully.

Task 6: Suppose that the government wants to promote full employment through the use of government spending. Should it increase or reduce government purchases? Explain your answer carefully.

Answer 1

Task 1: The macroeconomic equilibrium price level in this economy is 100 at which AD = AS.

Task 2: The macroeconomic equilibrium level of real GDP in this economy is 8 billion of dollars.

Task 3: If the full employment level of real GDP is $9 billion, and the current real GDP is $8 billion, this economy is experiencing a recessionary gap of $1 billion.

Task 4: Now government wants to promote full employment. Because there is a recessionary gap government should use expansionary fiscal policy.

Task 5: Now the government wants to promote full employment through the use of taxes. Government should lower taxes. This would increase disposable income and hence real GDP is increased which decreases recessionary gap via multiplier effect

Task 6: Suppose that the government wants to promote full employment through the use of government spending. Government should increase government purchases. This will increase aggregate expenditure and then real GDP via multiplier effect.