Suppose the economy is operating at an output of $4,000 billion. Assume furthermore that potential output is $5,000 billion and the marginal propensity to consume is 0.75. _____ would close this recessionary gap.
A)A $25 billion increase in government spending
B)A $25 billion increase in taxes
C)A $250 billion increase in government spending
D)A $1,000 billion increase in government spending

Question

Quizplus · Accepted Answer

The recessionary gap is the difference between actual output and potential output. In this case, the recessionary gap is $1,000 billion ($5,000 billion potential output - $4,000 billion actual output). To close this gap, an increase in government spending or a decrease in taxes is needed to stimulate aggregate demand. Option A and B will not be sufficient to close the recessionary gap. Option D is too large and will likely lead to inflationary pressures. Option C is the most suitable as it is large enough to close the recessionary gap, but not so large as to cause high inflation.

Suppose the Economy Is Operating at an Output of $4,000