The economy is in a recessionary gap.There is no crowding out and government has correctly estimated that to bring the economy into long-run equilibrium it should raise government purchases by $123 billion.If government purchases are raised by $123 billion,does it follow that the economy will be moved into long-run equilibrium?
A) Yes,because all the necessary conditions for effective fiscal policy are present.
B) No,because the economy may be self-regulating,and by the time expansionary fiscal policy is effective,the AD curve may intersect the SRAS curve at an inflationary-gap level of Real GDP.
C) Yes,because of the validity of the balanced budget theorem.
D) No,because of inflexible wages and the fact that the SRAS curve is upward-sloping.
E) none of the above

Question

Quizplus · Accepted Answer

Just because the government raises its purchases by $123 billion does not guarantee that the economy will be moved into long-run equilibrium. There may be self-regulating forces at play, and the AD curve may intersect the SRAS curve at an inflationary-gap level of Real GDP before the expansionary fiscal policy can take effect. Additionally, if wages are inflexible and the SRAS curve is upward-sloping, then the expansionary fiscal policy may only lead to higher prices and no increase in output. The balanced budget theorem is not relevant in this scenario.

The Economy Is in a Recessionary Gap