(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)
(Speaker)
This part is going to be similar to part one. But this time the economy is going to be experiencing an inflationary gap.
(Description)
Calculate the change in government purchases of goods and services necessary to close the recessionary or inflationary gaps in the following cases. Assume that the short-run aggregate supply curve is horizontal, so that the change in real GDP arising from a shift of the aggregate demand curve equals the size of the shift of the curve.
(Speaker)
In the first part, we are given real GDP equals 250 billion dollars. Potential output equals 200 billion dollars.
(Description)
On the Figure there is a graph of aggregate demand. Horizontal axis corresponds to real GDP. Vertical axis corresponds to aggregate price level. The demand line AD1 passing through points on two axes at the same distance from the origin is plotted. Two additional straight lines are plotted: LRAS line parallel to y-axis at 200 billion dollars real GDP and SRAS line parallel to x-axis at the aggregate price level P1 crossing demand line at (250 billion dollars, p1).
(Speaker)
The government collects 10 percent of any change in real GDP in the form of taxes. And the marginal propensity to consume is 0.5. To help visualize the problem, we have provided a graph showing the economy is currently in an inflationary gap.
(Description)
On the Figure there is a graph of aggregate demand AD1, LRAS and SRAS. The demand line AD1 passes through points on two axes at the same distance from the origin. Two additional straight lines are plotted: LRAS line parallel to y-axis at 200 billion dollars real GDP and SRAS line parallel to x-axis at the aggregate price level P1 crossing demand line at (250 billion dollars, p1). The interval between the intersection points of SRAS with LRAS and AD1 correspondingly is labeled "Inflationary gap".
(Speaker)
For this problem, the MPC is 0.5. And the tax rate has declined to 0.10. Using this values, we can solve for the multiplier and get a value of 1.82.
(Description)
Multiplier equals fraction, 1 in the numerator, 1 minus MPC times (1 minus t) in the denominator. Multiplier equals fraction, 1 in the numerator, 1 minus 0.5 times (1 minus 0.10) in the denominator, equals fraction, 1 in the numerator, 1 minus 0.45 in the denominator, equals 1.82.
(Speaker)
The next step is to find the size of the inflationary gap. If equilibrium GDP is 250 billion dollars, and potential output equals 200 billion dollars, the economy has an inflationary gap of negative 50 billion dollars. The negative sign reflects the fact that government needs to reduce spending to close the inflationary gap. To determine how much to decrease government spending, we simply divide the output gap by the multiplier. Doing so yields 50 billion dollars divided by 1.82, or approximately 27.5 billion dollars.
(Description)
Inflationary Gap equals 200 billion dollars minus 250 billion dollars, equals negative 50 billion dollars. Delta Government Purchases equals negative 50 billion dollars divided by 1.82, equals negative 27.5 billion dollars.
(Speaker)
This means we need to decrease government spending by 27.5 billion dollars to close the inflationary gap. If government purchases decrease by 27.5 billion dollars, real GDP will decrease by 50 billion dollars. The AD line will shift to the left. The economy will return to long-run equilibrium.
(Description)
Delta Y asterisk equals 1.82 times negative 27.5 billion dollars equals negative 50 billion dollars. On the Figure there is a graph of aggregate demand. The demand line AD1 passing through points on two axes at the same distance from the origin is plotted. Two additional straight lines are plotted: LRAS line parallel to y-axis at 160 billion dollars real GDP and SRAS line parallel to x-axis at the aggregate price level P1 crossing demand line at (100 billion dollars, p1). New aggregate demand line AD2 parallel to original and shifted to the left crossing intersection point of LRAS and SRAS is plotted. Arrows indicate the right shift with delta G equal to negative 27.5 billion dollars. And gap is closing with delta Y equal to negative 50 billion dollars as indicated by the arrow.