Assume that the marginal propensity to consume is 0.8 and potential output is $800 billion. If real GDP is $700 billion:
A)there is an inflationary gap.
B)there is a recessionary gap.
C)the economy is in long-run equilibrium.
D)government transfers should be decreased.

Question

Quizplus · Accepted Answer

The output gap can be calculated as potential output minus actual output, which would be $800 billion - $700 billion = $100 billion. Since the marginal propensity to consume is 0.8, this would result in an increase in aggregate demand of 0.8 x $100 billion = $80 billion. This increase in aggregate demand would cause prices to rise and output to increase. Therefore, there is a recessionary gap between actual output and potential output, indicating that the economy is operating below its full capacity.

Assume That the Marginal Propensity to Consume Is 0