Final answer:
The economy in question is experiencing a recessionary gap, where the current output is less than the full employment output, causing higher unemployment and underused capacity. To address this, adjustments in fiscal policy and understanding the multiplier effect are important considerations.
Step-by-step explanation:
A student has asked about an economy with a full employment output of $22 billion, a current output of $20.4 billion, and a marginal propensity to consume (MPC) of 0.75. This situation describes an economy that is experiencing a recessionary gap. A recessionary gap occurs when the current output level is below the full employment output, indicating that not all available resources, especially labor, are being utilized. Consequently, there is higher unemployment and underused capacity in the economy.
The concept illustrated in this example is similar to the Keynesian cross diagram analysis, which also deals with identifying output gaps. When aggregate expenditures are too low for GDP to reach its full employment level, we identify this as a recessionary gap, as represented in Figure B9 (a).
To address this gap, economic policies such as adjusting government spending or tax rates may be considered to influence aggregate demand and bring the economy back to its full employment output. The Keynesian policy prescription involves taking into account the multiplier effect, which states that an initial increase in spending will have a more significant impact on the real GDP than the initial amount spent due to the spending cycling through the economy.
After analyzing the scenario provided, the correct option answer in the final answer is: The economy is experiencing a recessionary gap.