Assume that the marginal propensity to consume is 0.8 and potential output is $800 billion. If GDP is $850 billion:
A)there is an inflationary gap.
B)there is a recessionary gap.
C)the economy is in long-run equilibrium.
D)taxes should be decreased.

Question

Quizplus · Accepted Answer

The marginal propensity to consume of 0.8 means that for every additional dollar of income, consumers will spend 80 cents. Therefore, if GDP is $850 billion and potential output is $800 billion, there is excess spending of $50 billion. This indicates an inflationary gap as the economy is producing more than its potential output, and this could lead to rising prices and inflation. To close this gap, policymakers may need to implement policies that reduce spending, such as increasing taxes or reducing government spending.

Assume That the Marginal Propensity to Consume Is 0