Question

EXERCISE1: ADAD, AD, Refer to the diagram, in which Of is the full- employment output. Price Level 1. A contractionary fiscal policy would be most appropriate if the economy's present aggregate demand curve were at Real GDP 2. An expansionary fiscal policy would be most appropriate if the economy's present aggregate demand curve were at 3. If the economy's present aggregate demand curve is , government should undertake neither an expansionary nor a contractionary fiscal policy. 4. At what AD level/s will the economy experience a negative GDP gap. 5. At what AD level/s will the economy experience a positive GDP gap. 6. If the economy is at ADO, name 2 appropriate government measures to adopt. Copyright 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the

Answer 1

1) Contractionary Fiscal policy would be most appropriate if the economy's present Aggregate Demand curve were at AD3 because at this this level, economy is not at its efficient output level (full employment level). It is above full emploment which creates inflationary pressure on the economy. So a contractionary Fiscal Policy would bring back AD to AD2.

2) Expansionary fiscal policy would be most appropriate if the economy's present Aggregate Demand curve at AD0 or AD1 as it would take economy to full employment output.

3) If Aggregate demand curve were at AD2, then goverment should undertake neither Expansionary nor contractionary fiscal policy.

4) At AD0 and AD1, economy would experience a Negative GDP gap.

5) At AD3, economy would experience a Positive GDP gap.

6) If economy is at AD0, 2 goverment measures should be a) Increase Public Works to increase employement b) Reduce Taxes of the lowest segment of income earners.