Question

Item 8Item 8 In a certain year, the aggregate amount demanded at the existing price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases. Full-employment GDP is $120 billion. To obtain price-level stability under these conditions, the government should

Answer 1

The government can reduce GDP by either:

1. lowering government expenses
2. increasing taxes which will lower consumption
3. or a combination of both

Step-by-step explanation:

currently total GDP = $100 billion (C) + $40 billion (I) + $20 billion (G) + $10 billion (X) = $170 billion

since the full employment GDP = $120 billion, the government must lower the GDP by $50 billion before inflation starts to rise.

The government can reduce GDP by either:

1. lowering government expenses
2. increasing taxes which will lower consumption
3. or a combination of both

We aren't given any more information regarding MPC or MPS, so it is not possible to calculate by how much should government spending be lowered or taxes increased.