If the equilibrium real GDP were higher than potential GDP, then a contractionary fiscal policy would cause the inflation rate to be ________ and real GDP to be ________.
A)higher; higher
B)higher; lower
C)lower; higher
D)lower; lower

Question

Quizplus · Accepted Answer

If the equilibrium real GDP is higher than potential GDP, it indicates that the economy is already operating above its long-term capacity, and there is excess demand. In such a situation, contractionary fiscal policy, such as lower government spending or higher taxes, would reduce aggregate demand and result in lower output and higher unemployment. This would lower the inflation rate as the reduced demand lowers the pressure on prices. Therefore, the inflation rate would be lower, and real GDP would be lower.

If the Equilibrium Real GDP Were Higher Than Potential GDP