Question

suppose that real gdp is currently $20.4 trillion, potential gdp is $23.5 trillion, the government purchases multiplier is 2.0, and the tax multiplier is -1.6. holding other factors (such as prices and interest rates) constant, how will government purchases (g) need to change to bring the economy to equilibrium at potential gdp?

Answer 1

The government needs to increase its purchases by $1.55 trillion to bring the economy to the potential GDP, using the given government purchases multiplier of 2.0 to close the $3.1 trillion output gap.

To determine how government purchases (G) need to change to bring the economy to equilibrium at potential GDP, we can use the government purchases multiplier.

The real GDP is currently $20.4 trillion and potential GDP is $23.5 trillion, which means that the output gap is $23.5 trillion - $20.4 trillion = $3.1 trillion.

The government purchases multiplier is given as 2.0.

To close the output gap using the government purchases multiplier, we calculate the required change in government spending by dividing the output gap by the multiplier.

That is:

ΔG = Output Gap / Government Purchases Multiplier

ΔG = $3.1 trillion / 2.0 = $1.55 trillion

Therefore, the government needs to increase its purchases by $1.55 trillion to bring the economy to the potential GDP, assuming other factors remain constant.