In an economy where planned aggregate spending is given by PAE = 5,500 + 0.6Y − 20,000r, the interest rate is currently 2 percent (0.02). If potential output equals 8,000, the central bank must ________ the interest rate to close the ________ gap.
A)lower; expansionary
B)lower; recessionary
C)raise; recessionary
D)raise; expansionary

Question

In an economy where planned aggregate spending is given by PAE = 5,500 + 0.6Y − 20,000r, the interest rate is currently 2 percent (0.02). If potential output equals 8,000, the central bank must ________ the interest rate to close the ________ gap.
A)lower; expansionary
B)lower; recessionary
C)raise; recessionary
D)raise; expansionary

Quizplus · Accepted Answer

If potential output is 8,000, this economy has an expansionary gap. PAE = 5,500 + 0.6(Y) − 20,000(0.02), so 0.4Y = 5,100 and Y = 12,750. This is an expansionary gap of 4,750 and interest rates must be raised to close the gap.

In an Economy Where Planned Aggregate Spending Is Given by PAE