Question

The following table shows economic information regarding the current year and the forecast for the next year:

Year Potential GDP Real GDP Price Level Present $18.5 trillion $18.5 trillion 114.7 Future Year $20.8 trillion $20.1 trillion 118.3
Should Congress & the President use expansionary or contractionary fiscal policy in the current year? Consistent with this answer, should they raise or lower government purchases? Should they raise or lower taxes?
If Congress & the President succeed in achieving real GDP in the current year that reaches its potential level, will each of the following be higher, lower, or the same in future years as it would have been if they had taken no action (explain each of your answers):
A. Real GDP
B. Potential GDP
C. The inflation rate
D. The unemployment rate

Answer 1

Congress and the President should use expansionary fiscal policy such as increasing government spending and reducing taxes to stimulate the economy. If successful, this could lead to a higher Real GDP and lower unemployment rate in the future, though it may also result in a higher inflation rate.

Step-by-step explanation:

The table provided shows that the current Real GDP equals the Potential GDP and the forecast is for Real GDP to increase but still fall short of Potential GDP next year. In light of this information, the fiscal policy that should be used in the current year is an expansionary fiscal policy to stimulate the economy and help the Real GDP reach or exceed the Potential GDP.

With an expansionary fiscal policy, government purchases should be increased which will directly boost aggregate demand and, hence, Real GDP. On the other hand, taxes should be lowered to increase consumers' disposable income and consequently their spending, which also helps stimulate economic activity.

If successful in achieving Real GDP at the potential level, the impact on the future year would be as follows:

• A. Real GDP: It is likely to be higher due to the increased capacity and improved economic conditions.
• B. Potential GDP: It will continue to grow as long as factors like technology and labor force continue to improve.
• C. The inflation rate: It may be higher due to increased demand and spending.
• D. The unemployment rate: It will likely be lower due to higher production needs and economic activity.