Question

When the country of Econoland is at full-employment, the level of output is $225 billion. Unfortunately

for Econolanders, the current level of output is $525 billion. The MPC in Econoland is .8:
a. What is the current economic problem in Econoland?
C.
b. Draw a properly labeled graph for Econoland's macro-economy based on the information above.
Based on this problem, should policy makers use an expansionary or contractionary fiscal policy
to solve the problem?
d. Show the appropriate shift on the graph based on the policy that was selected in part C.
What is the size of the initial GDP gap?
e.
Using the data provided above (the bolded and underlined numbers), calculate the amount of
government spending that would be required to return Econoland to full-employment.
g. Using the data provided above (the bolded and underlined numbers), calculate the amount of
tax change that would be required to return Econoland to full-employment.
h. What amount of government spending and tax would be required to return Econoland to full-
employment if:
i.
20% was changed with spending
ii. 80% was changed with a tax

Answer 1

The current economic problem in Econoland is an issue of excessive demand and potential inflation.

A contractionary fiscal policy is the best policy to use to calm the economy and prevent inflation from spiraling out of control.

When the country is at full employment, the level of output is $225 billion but the current level of output is significantly higher at $525 billion, this suggests that the economy is producing well beyond its maximum sustainable capacity.

The MPC (Marginal Propensity to Consume) in Econoland is 0.8, this means that consumers are spending 80% of any additional income they receive. With output exceeding the full-employment level by such a large margin, it means demand in the economy is excessive.

This could lead to inflationary pressures as businesses struggle to meet the heightened demand and cause prices to rise. To address this, Econoland may need to implement measures to reduce aggregate demand such contractionary fiscal policy to cool down the economy and prevent inflation from spiraling out of control.