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 exports = $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: C. Decrease government spending and increase taxes

Explanation:

The current GDP of this economy is $670 billion and this figure is higher than the $620 billion that the economy should be at.

This means that the economy is in danger of overheating and needs to be adjusted.

To do this one can use option C.

By REDUCING Government Expenditure, government purchases will drop which will aid in reducing the GDP.

By also INCREASING Taxes, the amount of money left for people to consume after they pay their taxes is less so that REDUCES Consumption as well leading to a smaller GDP.

Doing this is known as a CONTRACTIONARY FISCAL POLICY.