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Recessionary output gap or inflationary output gap

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The economy of IVAland is in short-run macroeconomic equilibrium. The current real output is $300 billion, and the full employment output is $200 billion. The marginal propensity to consume is 0.5.

1. Is the economy experiencing a recessionary output gap or an inflationary output gap? Explain.

2. Assume IVALands's government is considering taking action to close the output gap identified in part (a).

(i) Calculate the minimum change and indicate the direction of change in government spending required to shift the aggregate demand curve to close the output gap. Show your work.

(ii) If instead IVALand's government changes taxes without changing government spending, calculate the minimum change and indicate the direction of change in taxes required to shift the aggregate demand curve to close the output gap. Show your work.

3. Which fiscal policy action, changing government spending or changing taxes, is more effective in closing the output gap? Explain.

4. Assume instead IVALands's government decides not to take any policy action. Will short-run aggregate supply increase, decrease, or stay the same in the long run? Explain.

Reference no: EM133338412

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