Consider the following economic data: Unemployment rate= 5% Inflation rate= 2% R
ID: 1206052 • Letter: C
Question
Consider the following economic data:
Unemployment rate= 5%
Inflation rate= 2%
Real GDP= $18 trillion
Growth rate= 2%
Natural rate of unemployment= 4%
Potential GDP= $20 trillion
Marginal Propensity to consume=.8
Based on the data, answer the following:
What data indicate there is a problem?
Explain. [type your answers here]
Identify what kind of GDP gap this economy is experiencing.
Why is this a problem? [type your answers here]
State a fiscal policy option to fix the problem.
How will your proposal fix the problem?
[type your answers here] State a monetary policy option to fix the problem.
How will your proposal fix the problem? [type your answers here]
Given the power of the multiplier, how much must spending change to reach potential GDP?
Explanation / Answer
What data indicate there is a problem?
The real GDP and real Unemploynment are n't equal to potential GDP and Natural rate of unemploynment.
Identify what kind of GDP gap this economy is experiencing.
Why is this a problem? [type your answers here]
GDP gap this economy is experiencing is the recessionary gap. This is problem because at this point economy is producing less than its potential output and firms are having excess capacity and are producing at less then there capacity and thus are hiring labour less than the natural level , so there will be more unemployed than the natural rate of unemploynment.
State a fiscal policy option to fix the problem.
Expansionary fiscal policy like decrease in taxes,and increase in government spending can fix this problem
How will your proposal fix the problem?
Increase in government spending or decrease in taxes fixes as due to decrease in taxes, the disposable income of the people increases , thus their consumption increases which leads to shif in the Aggregate demand to the right , so firms start to produce more to meet this increase in AD ,and hires more workers, Thus unemplonment decreases to natural rate of employnment and the real output/GDP increases to its potential level.
[type your answers here] State a monetary policy option to fix the problem.
Expansionary monetary policy like decrease in Funds rate will fix the problem
How will your proposal fix the problem? [type your answers here]
Due to increase in the funds rate , the supply of the money in the economy increases as banks now has more money and will be willing to provide loans at cheaper prices . this makes the SRAS curve to shift to the right , thus increasing the money supply , and reducing the interest rates , thus due to decrease in the interest rates , Investment in the economy increases to increase the output/GDP ,thus more workers will be hired to produce this increased output , and thus the real unemplonment falls and becomes equal to the natural rate of the unemploynment and GDP increases to its potential level.
Given the power of the multiplier, how much must spending change to reach potential GDP?
GDP Gap = Potential GDP - Actual GDP = 20 - 18 = 2 trillion
Multiplier*increase in spending = Increase in GDP
1/1-MPC*increase in spending = 2
(1/1-0.8)* increase in spending = 2
increase in spending = 2/5 = 0.4
So increase in spending = 0.4 trillion