The diagram below shows two budget deficit functions for a hypothetical economy.
FIGURE 31-2
-Refer to Figure 31-2.Initially,suppose the economy is at point A on budget deficit function B0.Real GDP (Y)is $100 million.If the level of potential output (Y*)were $300 million,how much of the actual budget deficit is due to the underlying structure of fiscal policy and is therefore independent of the current level of GDP?

Question

The diagram below shows two budget deficit functions for a hypothetical economy.
  FIGURE 31-2
-Refer to Figure 31-2.Initially,suppose the economy is at point A on budget deficit function B0.Real GDP (Y)is $100 million.If the level of potential output (Y*)were $300 million,how much of the actual budget deficit is due to the underlying structure of fiscal policy and is therefore independent of the current level of GDP?

Quizplus · Accepted Answer

At point A, the actual budget deficit is $10 million. If Y* is $300 million, then the potential budget deficit (or the deficit that would occur if the economy were at potential output) is $3 million, as shown by point C on the B0 function. The difference between the actual and potential budget deficits, which represents the portion of the actual deficit due to the underlying structure of fiscal policy, is $10 million - $3 million = $7 million or $7.5 million according to the graph. Therefore, the answer is C.

The Diagram Below Shows Two Budget Deficit Functions for a Hypothetical