Question

Use the following information to answer questions 3 - 10 Y- C+IG+X-IM where: C= 200 + 0.75 DI I = 100 G 100 X = 100 IM 200 Also assume that T Tr-0 full-employment real GDP (YF) $2000

Answer 1

Q) 6. The expenditure multiplier is 1/1-MPC , here MPC =0.75. Therefore 1/1-MPC = 1/1-0.75 =1/0.25 =4. The oversimplified expenditure multiplier is 4.

Q)7. Y= C+I+G+X - IM , or Y = 200+ 0.75DI +100 + 100 +100 -200 , or Y = 200+ 0.75Y +100, (as DI=Y - T + Tr and T= Tr =0). Therefore Y = 300 + 0.75Y , or Y - 0.75Y = 300, or 0.25Y = 300 , or Y =1200. Therefore Y* =$1200. But full employment real GDP = $2000. The GDP gap is difference between potential GDP and real GDP. When real GDP fall short of potential GDP then output or GDP is positive and it is called recessionary gap. When actual GDP is higher than potential GDP then it is called inflationary gap. Here real GDP =$1200 and potential GDP =$2000. So potential GDP > real GDP implies recessionary gap = $2000 - $1200 = $800.

So answer is third option. Recessionary gap equal to $800.