Consider the following diagram, in which the current short-run equilibrium is at
ID: 1148447 • Letter: C
Question
Consider the following diagram, in which the current short-run equilibrium is at point A. Please answer part B.
Text Problem 13-10 Consider the following diagram, in which the current short-run equilibrium is at point A. a. At point A, the economy has an inflationary gap b. If the marginal propensity to consume equals 0.9, to eliminate the gap, the government should decrease spending by LRAS SRAS trillion (Round your answer to two decimal places.) 114 AD 18 18.8 19.6 Real GDP per Year (5 trillion)Explanation / Answer
Consider the given problem here the SR equilibrium is “A”, where “AD” and “SRAS” intersect. Now there is an inflationary gap as the equilibrium “Y” is more than “18=the natural level of output”. So, here the govt. should reduce “G” in such a way that a new LR equilibrium will establish where “AD, SRAS and LRAS” will intersect to each other. So, the govt. should reduce “G” such that “dY = (18-19.6) = (-1.6)”.
So, dY = dG/(1-MPC) = dG/0.1, => dG = 0.1*dY = 0.1*(-1.6) = (-0.16) < 0.
=> govt. should reduce “G” by “0.16” trillion to achieve the natural level of output.