Assume that full-employment real GDP is Y = $1,200 billion, the current equilibrium real GDP is Y = $1,600 billion, and the MPC = 0.8. In order to bring the economy to a full-employment real GDP,
A) a recessionary gap must be bridged by increasing aggregate expenditures by $80 billion.
B) an inflationary gap must be bridged by cutting aggregate expenditures by $80 billion.
C) an inflationary gap must be bridged by cutting aggregate expenditures by $400 billion.
D) a recessionary gap must be bridged by increasing aggregate expenditures by $400 billion.

Question

Quizplus · Accepted Answer

The economy is producing above full-employment GDP, indicating an inflationary gap. The gap is $400 billion ($1,600 billion - $1,200 billion). With an MPC of 0.8, the multiplier is 5 (1/(1-0.8)). To close the gap, aggregate expenditures need to be reduced by $80 billion ($400 billion / 5).

Assume That Full-Employment Real GDP Is Y = $1,200 Billion