Equilibrium at the full-employment level of production

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In the long run, economies are expected to move toward equilibrium at the full-employment level of production. Governments, particularly in democratic countries with frequent elections, often try to use economic policy in the shortrun to improve the nation's economy. Consider a country experiencing a recession. The legislature is considering the use of fiscal policy measures to bring output up to the full-employment level. The government's commerce ministry has reported to the legislature that the nation's marginal propensity to consume is 0.8 and that RGDP is $200 billion below the full-employment level.

A. The Minister of Commerce recommends deficit spending to stimulate the economy. What increase in spending is necessary to bring the economy up to the full-employment level of output?

B. Legislative leaders favor a tax cut over a spending increase as a response to the recession. What size tax cut would bring the economy up to the full-employment level of output?

C. The country's president wants the legislature to pass a balanced-budget spending increase to end the recession. What increase in spending would be necessary to carry out the president's plan?

D. The head of the central bank of this country believes that because of the different proposals before the legislature, fiscal policy measures will not be taken any time soon. What monetary policy options can the central bank pursue to end the recession? What could prevent these measures from being effective? Explain your answers.

Reference no: EM131098368

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