When total expenditures exceed the economy's potential GDP, the proper fiscal policy is to
A)increase transfer payments to the poor and elderly.
B)cut personal income tax rates.
C)decrease government purchases.
D)increase purchasing power.

Question

Quizplus · Accepted Answer

When total expenditures exceed the economy's potential GDP, it leads to inflationary pressures. To counter inflation, the government should decrease its own purchases, which reduces aggregate demand, putting downward pressure on prices. This can be achieved through reducing government spending or raising taxes or a combination of both. Therefore, the proper fiscal policy is to decrease government purchases. Other options such as increasing transfer payments or personal income tax cuts would further increase aggregate demand, exacerbating the problem of inflation. Similarly, increasing purchasing power would also increase aggregate demand and worsen inflation.

When Total Expenditures Exceed the Economy's Potential GDP, the Proper