Question

In a certain year, the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases. Full-employment GDP is $120 billion. To obtain price-level stability under these conditions, the government should

Answer 1

Answer:

The answer is: decrease government spending or increase tax rates.

Explanation:

Nominal GDP is currently $170 billions (= $100 billions + $40 billions + $20 billions + $10 billions).

Since full employment GDP = $120 billions, the nominal GDP is much higher ($170 billions > $120 billions). So the government must try to cool the economy and the two main ways it can do it is by reducing government spending or by raising taxes which will lower private consumption.