Question

You are given the following information about aggregate demand at the existing price level for an economy: (1) consumption = $500 billion; (2) investment = $50 billion; (3) government purchases = $100 billion; and (4) net export = $20 billion. If the full-employment level of GDP for this economy is $620 billion, then what combination of actions would be most consistent with closing the GDP-gap here?

Answer 1

Answer: The answer is as follows:

Explanation:

Potential GDP = consumption + investment + government purchases + net export

= 300 + 50 + 100 + 20

= $470

If the full-employment level of GDP for this economy is $620 billion.

In this situation, potential GDP is less than the real output or GDP at full employment level. From the above calculation, the potential GDP is $470 and GDP at full employment is $620. So, there is a gap of $150 between Potential GDP and real output.

Therefore, government should increase the spending and cut down taxes to reduce the GDP-gap.