In an economy where planned aggregate spending is given by PAE = 3,000 + .75Y − 10,000r, the central bank is currently setting the interest rate at 0.06 (6 percent). If potential output equals 9,500, the central bank must ________ the interest rate to close the ________ gap.
A)lower; expansionary
B)raise; expansionary
C)lower; recessionary
D)raise; recessionary

Question

Quizplus · Accepted Answer

If potential output is 9,500, this economy has an expansionary gap. PAE = 3,000 + 0.75(Y)− 10,000(0.06), so 0.25Y = 2,400 and Y = 9,600. This is an expansionary gap of 100 and interest rates must be raised slightly to close the gap.

In an Economy Where Planned Aggregate Spending Is Given by PAE