Consider the hypothetical information in the following table for potential GDP,real GDP,and the price level in 2017 and in 2018 if the government does not use fiscal policy. $$\begin{array} { | c | c | c | c | }
\hline \text { Year } & \text { Potential GDP } & \text { Real GDP } & \text { Price Level } \
\hline 2017 & \$ 1.5 \text { trillion } & \$ 1.5 \text { trillion } & 150 \
\hline 2018 & \$ 1.7 \text { trillion } & \$ 1.6 \text { trillion } & 152 \
\hline
\end{array}$$ If the government wants to keep real GDP at its potential level in 2014,it should _________.
A) decrease income taxes
B) decrease government purchases
C) decrease interest rates
D) increase interest rates

Question

Consider the hypothetical information in the following table for potential GDP,real GDP,and the price level in 2017 and in 2018 if the government does not use fiscal policy. $$\begin{array} { | c | c | c | c | } 
\hline \text { Year } & \text { Potential GDP } & \text { Real GDP } & \text { Price Level } \
\hline 2017 & \$ 1.5 \text { trillion } & \$ 1.5 \text { trillion } & 150 \
\hline 2018 & \$ 1.7 \text { trillion } & \$ 1.6 \text { trillion } & 152 \
\hline
\end{array}$$ If the government wants to keep real GDP at its potential level in 2014,it should _________.
A) decrease income taxes
B) decrease government purchases
C) decrease interest rates
D) increase interest rates

Quizplus · Accepted Answer

Looking at the table, we can see that in 2018, real GDP is below potential GDP, indicating a recessionary gap. To bring real GDP back to its potential level, the government can use expansionary fiscal policy, which involves increasing government spending and/or decreasing taxes. Since decreasing taxes (choice A) would put more money in consumers' hands and increase aggregate demand, it is the best choice in this scenario. Decreasing government purchases (choice B) would have the opposite effect and could exacerbate the recessionary gap. Decreasing interest rates (choice C) is a monetary policy tool, not fiscal, and would only be effective if the problem was high interest rates hindering investment and consumption. Increasing interest rates (choice D) would be counterproductive in this situation and likely worsen the recessionary gap.

Consider the Hypothetical Information in the Following Table for Potential