Question

Congratulations! You have been appointed an economic policy adviser to the U.S. You are told that the economy is significantly underutilizing its available resources and that the following will happen the next year: World recession will continue and the prices of oil will increase significantly. An adequate policy to move the economy back to GDP of full employment is:

Multiple Choice

• Expansionary FP: Higher G, shifting the AD to the right, and eventually increasing GDP.

• Contractionary FP: Higher G, shifting the AD to the right, and eventually increasing GDP.

• Expansionary FP: Higher G, shifting the AD to the left, and eventually increasing GDP.

• Contractionary FP: Lower G, shifting the AD to the left, and eventually decreasing GDP.

Answer 1

Question

It has been stated that the economy is significantly under-utilizing its available resources.

This means economy is in recession.

When economy is in recession, government must administer expansionary fiscal policy.

This expansionary fiscal policy in terms of increase in government spending will lead to increase in aggregate demand and would shift the AD curve to the right.

Given the SRAS curve, this rightward shift of AD curve will bring an increase in GDP.

So,

An adequate policy move is -

Expansionary FP: Higher G, Shifting the AD to the right, and eventually increasing GDP.

Hence, the correct answer is the option (A).