In a certain year the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government
Purchases. Full-employment GDP is $200 billion. To obtain full employment under these conditions, the
Government should
A) encourage personal saving by increasing the interest rate on government bonds.
B) decrease government expenditures.
C) reduce tax rates and/or increase government spending.
D) discourage private investment by increasing corporate income taxes.

Question

Quizplus · Accepted Answer

To achieve full employment GDP, aggregate demand (total spending) should equal the potential GDP. In this case, the aggregate demand is $170 billion ($100 consumption + $40 investment + $10 net exports + $20 government purchases), which is less than the potential GDP of $200 billion. To increase aggregate demand and achieve full employment, the government should stimulate the economy by reducing tax rates and/or increasing government spending, which would increase the disposable income and consumption levels of individuals and businesses. Encouraging personal saving or decreasing government expenditures would likely decrease aggregate demand and exacerbate the recessionary gap. Discouraging private investment would also decrease aggregate demand and reduce economic growth.

In a Certain Year the Aggregate Amount Demanded at the Existing