Chapter 20, Problem 1FRQ

a)

To determine

The type of that gap exists in the economy.

Explanation of Solution

This gap is an inflationary gap because there is a difference between the current level of real GDP and the GDP, which operates at the level of full employment in the economy.

Economics Concept Introduction

Introduction: Fiscal policy is a policy through which government spending and tax policies are used to make economic conditions better. And, the monetary policy increases or decreases the supply of money with the control of interest rates.

b)

To determine

Type of fiscal policy which is appropriate in this situation.

Explanation of Solution

A contractionary fiscal policy would be appropriate in this situation because through this policy, the government can increase the tax rate and lower its spending to siphon money from the private industry so that unsustainable production would slow down and prices would decrease. Through this fiscal policy, the government would reduce or control the inflationary gap.

Economics Concept Introduction

Introduction: Fiscal policy is a policy through which government spending and tax policies are used to make economic conditions better. And, the monetary policy increases or decreases the supply of money with the control of interest rates.

c)

To determine

Three variables that government can change to implement the fiscal policy

Explanation of Solution

In this case, the three variables that government would change to implement the fiscal policy are taxes, government transfers, and government spending on goods and services because the change in these variables will help the government to protect the economy against the inflationary gap.

Economics Concept Introduction

Introduction: Fiscal policy is a policy through which government spending and tax policies are used to make economic conditions better. And, the monetary policy increases or decreases the supply of money with the control of interest rates.

d)

To determine

The way through which the government can change each of the three variables to implement the policy.

Explanation of Solution

To implement the contractionary fiscal policy the government would increase tax rates, decrease its transfers, and also decrease its spending on goods and services. The government would make these changes to siphon money from the private industry so that unsustainable production would slow down and prices would decrease which in turn controls the inflationary gap.

Economics Concept Introduction

Introduction: Fiscal policy is a policy through which government spending and tax policies are used to make economic conditions better. And, the monetary policy increases or decreases the supply of money with the control of interest rates.