Question

The graph below depicts an economy where a decline in aggregate demand has caused a recession. Assume the government decides to conduct fiscal policy by increasing government purchases to reduce the burden of this recession. Fiscal Policy LRAS Price Level 80 160 240 320 400 480 560 640 720 800 Real GDP (billions of dollars) Instructions: Enter your answers as a whole number. a. How much does aggregate demand need to change to restore the economy to its long-run equilibrium? $ O billion b. If the MPC is 0.6, how much does government purchases need to change to shift aggregate demand by the amount you found in part a? $ [ billion Suppose instead that the MPC is 0.75. c. How much does aggregate demand and government purchases need to change to restore the economy to its long-run equilibrium? Aggregate demand needs to change by $ O b illion and government purchases need to change by $ O b illion.

Answer 1

The aggregate demand needs to increase to shift the economy back to long-run equilibrium, and the extent of change in government purchases depends on the MPC. A higher MPC means that for every dollar increase in government spending, a larger portion will be spent, thus requiring less spending to achieve the desired increase in aggregate demand.

Step-by-step explanation:

The student's question is about how much aggregate demand needs to change to restore an economy to its long-run equilibrium after a recession, and how this change affects government purchases, especially considering different values of the marginal propensity to consume (MPC).

In the scenarios described by the figures, we observe a recession where a decline in aggregate demand has resulted in an output level below potential GDP, and the expansionary fiscal policy is used as a tool to shift the aggregate demand curve back to the right, towards full employment.

To restore the economy to its long-run equilibrium, aggregate demand must be increased to shift the demand curve to the point where it intersects the short-run aggregate supply curve at potential GDP.

The amount of government purchases required to implement this fiscal policy change will depend on the MPC, with a higher MPC requiring a smaller increase in government spending to achieve the same effect on aggregate demand.

For instance, if the MPC is 0.75, a certain amount of government spending will have a larger effect than if the MPC were 0.6, since more of the additional income will be spent.

Answer 2

To restore the economy to its long-run equilibrium, aggregate demand needs to increase by $240 billion. If the MPC is 0.6, government purchases need to increase by $144 billion.

Step-by-step explanation:

The graph below depicts an economy where a decline in aggregate demand has caused a recession. To restore the economy to its long-run equilibrium, aggregate demand needs to increase by $240 billion (from $400 billion to $640 billion).

If the MPC is 0.6, to shift aggregate demand by $240 billion, government purchases need to increase by $144 billion (0.6 x $240 billion).

If the MPC is 0.75, to restore the economy to its long-run equilibrium, aggregate demand needs to increase by $240 billion and government purchases need to increase by $180 billion (0.75 x $240 billion).