Question

If potential output equals $8 billion and actual output equals $9 billion, then this economy has a(n):

A. trade deficit.
B. recessionary gap.
C. expansionary gap.
D. budget deficit.

Answer 1

The correct answer is C. expansionary gap. An expansionary gap occurs when the actual output (real GDP) is greater than the potential output. To address an expansionary gap, policies such as tax increases or spending cuts can be implemented.

Step-by-step explanation:

The correct answer is C. expansionary gap.

An expansionary gap occurs when the actual output (real GDP) is greater than the potential output. In this case, the actual output is $9 billion, which is greater than the potential output of $8 billion. This indicates that the economy is producing more than it is capable of producing at full employment.

To address an expansionary gap, policies such as tax increases or spending cuts can be implemented to shift the aggregate expenditure schedule down from AE to AE₁, bringing the equilibrium output back to the potential GDP level.