There is an inflationary gap of $500 m in the full SR model, IS-LM; and I=450 + 0.25Y-1500i; C=350+.65 YD. Calculate the required to policy and show what will happen, cet. par., in the appropriate graph.

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ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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There is an inflationary gap of $500 m in the full SR model, IS-LM; and I=450 + 0.25Y-1500i; C=350+.65 Y_D. Calculate the required t_o policy and show what will happen, cet. par., in the appropriate graph.

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Step 1

Inflationary gap implies that there is extra expenditure (beyond what is needed to reach the potential GDP) in the economy and since the output is not enough to absorb this level of expenditure, spending will lead to inflationary rise in the price levels.

In order to close an inflationary gap , contractionary fiscal policy is adopted.

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