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S169-S182_Krug2e_Macro_PS_Ch13.qxp

2/25/09

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Page S-169

Fiscal Policy
1.
The accompanying diagram shows the current macroeconomic situation for the economy of Albernia. You have been hired as an economic consultant to help the economy move to potential output, YP.
Aggregate price level

LRAS

SRAS

P1

E1

AD1
Y1 YP

Potential output

Real GDP

a. Is Albernia facing a recessionary or inflationary gap? b. Which type of fiscal policy—expansionary or contractionary—would move the economy of Albernia to potential output, YP ? What are some examples of such policies? c. Illustrate the macroeconomic situation in Albernia with a diagram after the successful fiscal policy has been implemented.

1. Solution

a. Albernia is facing a recessionary gap; Y1 is less than YP.

b. Albernia could use expansionary fiscal policies to move the economy to potential output. Such policies include increasing government purchases of goods and services, increasing government transfers, and reducing taxes. c.
Aggregate price level

LRAS

SRAS

P2 P1

E2 E1 AD2 AD1
Y1 YP Real GDP

Potential output

Recessionary gap

S-169

MACROECONOMICS

29 13
ECONOMICS

chapter:

S169-S182_Krug2e_Macro_PS_Ch13.qxp

2/25/09

8:02 PM

Page S-170

S-170

MACROECONOMICS, CHAPTER 13 ECONOMICS, CHAPTER 29

2.

The accompanying diagram shows the current macroeconomic situation for the economy of Brittania; real GDP is Y1, and the aggregate price level is P1. You have been hired as an economic consultant to help the economy move to potential output, YP.
Aggregate price level P1

LRAS

SRAS E1

AD1

Potential output

YP

Y1

Real GDP

a. Is Brittania facing a recessionary or inflationary gap? b. Which type of fiscal policy—expansionary or contractionary—would move the economy of Brittania to potential output, YP? What

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