An economy characterized by the AD equation P = 220

Question

An economy characterized by the AD equation P = 220 - 0.02Y,SRAS equation P = 100,and LRAS equation Y* = 7,000 has a recessionary gap equal to ___________.In an attempt to eliminate this output gap,the policy authorities engineer a shift in the AD curve to the position P = 240 - 0.02Y.It may be concluded that the policy will ___________ in achieving its goal because the authorities have ___________ the size of recessionary gap.

Quizplus · Accepted Answer

The initial equilibrium output is found by setting AD equal to SRAS: 220 - 0.02Y = 100, which gives Y = 6,000. The recessionary gap is the difference between potential output (Y* = 7,000) and actual output (Y = 6,000), which is 1,000. The new AD curve is P = 240 - 0.02Y. Setting this equal to SRAS (P = 100) gives Y = 7,000, which closes the recessionary gap, indicating the policy will succeed.