Reference no: EM133465764

Skeetervale's economy is in short-run equilibrium with a recessionary gap of $240 billion, and the marginal propensity to save is 0.25. The expected inflation rate is 4%, and the natural rate of unemployment is 2%.

1. Based on the Phillips curve model, is the actual inflation rate greater than, less than, or equal to the expected inflation rate of 4% in Skeetervale? Explain.

2. Assume the government takes no policy action with regard to the state of Skeetervale's economy.(i) What will happen to the actual rate of unemployment in the long run? Explain.(ii) How will the long-run adjustment process be represented in the Phillips curve model? Explain.

3. Assume that instead of waiting for the long-run adjustment, the government of Skeetervale is considering using fiscal policy to address the recessionary gap of $240 billion.(i) If the government chooses to increase its deficit spending, calculate the minimum change in government spending required to increase aggregate demand by the amount of the recessionary gap. Show your work.(ii) How will the effect of the government's action in part (c)(i) be represented in the Phillips curve model? Explain.(iii) If the government chooses to decrease income taxes instead of increasing its spending, calculate the minimum change in income taxes required to increase aggregate demand by the amount of the recessionary gap. Show your work.(iv) Now suppose instead that the government wants to maintain a balanced budget and increases both government spending and income taxes by $200 billion. Will this policy make the output gap smaller, make the output gap larger, or have no effect on the output gap? Explain.

4. Suppose the government chose to implement only the policy described in part (c)(i). Based on loanable funds market analysis, what will happen to each of the following?(i) The price of previously issued bonds. Explain.(ii) Capital stock. Explain.