Suppose real GDP is $1.7 trillion, potential real GDP is $1.75 trillion, and the federal government plans to use fiscal policy to restore the economy to potential real GDP.Assuming a constant price level, the federal government would need to decrease taxes by

Question

Quizplus · Accepted Answer

Since the economy is operating below its potential, the government needs to increase aggregate demand. One way to do that is by decreasing taxes, which will increase disposable income and therefore consumption expenditure. The amount by which taxes need to be decreased can be calculated by subtracting real GDP from potential real GDP, which gives us $1.75 trillion - $1.7 trillion = $50 billion. Therefore, the federal government would need to decrease taxes by less than $50 billion to restore the economy to potential real GDP.

Suppose Real GDP Is $1