is this a recessionary or inflationary gap. aggregate supply curve is horizontal, change in real GDP arising from a shift of the aggregate demand curve = the size of the shift of the curve. Calculate both the change in government purchases of goods and services and the change in government transfers necessary to close the gap.
real GDP = $180billion, potential output = $100billionn and the marginal propensity to consume is .8
To determine whether this is a recessionary or inflationary gap, we need to compare the level of real GDP to the potential output.
1. Calculate the size of the output gap:
Output Gap = Potential Output - Real GDP
Output Gap = $100 billion - $180 billion
Output Gap = -$80 billion
Based on the negative output gap, we can determine that this is a recessionary gap.
Now, let's move on to calculating the change in government purchases of goods and services and the change in government transfers necessary to close the gap.
2. Calculate the change in government purchases of goods and services:
Change in Government Purchases = Output Gap / Marginal Propensity to Consume
Change in Government Purchases = -$80 billion / 0.8
Change in Government Purchases = -$100 billion
The change in government purchases of goods and services necessary to close the gap is -$100 billion.
3. Calculate the change in government transfers:
Change in Government Transfers = Change in Government Purchases * (1 - Marginal Propensity to Consume)
Change in Government Transfers = -$100 billion * (1 - 0.8)
Change in Government Transfers = -$100 billion * 0.2
Change in Government Transfers = -$20 billion
The change in government transfers necessary to close the gap is -$20 billion.
Therefore, to close the recessionary gap, the government needs to decrease government purchases of goods and services by $100 billion and decrease government transfers by $20 billion.