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Consider an economy in equilibrium with a recessionary gap. Draw a graph where the equilibrium real GDP is $8 trillion and the price level of 150. Label this equilibrium E 1 where the aggregate demand, AD 1 , intersects the short-run aggregate supply curve ( SRAS 1 ). Include in your graph a long-run aggregate supply curve (LRAS) at the full-employment Real GDP level of, say, $12 trillion. a. From a keynesian perspective, what should government do with its fiscal and monetary policies to achieve full employment? How is this expansionary policy reflected in terms of the aggregate demand curve? Illustrate this in your graph. b. Illustrate long-run equilibrium on your graph as E 2 . What has happened to real GDP and the price level as a result of Keynesian policy to achieve full employment in this long run?

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Economics For Today

10th Edition
Tucker
Publisher: Cengage Learning
ISBN: 9781337613040

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BuyFindarrow_forward

Economics For Today

10th Edition
Tucker
Publisher: Cengage Learning
ISBN: 9781337613040
Chapter 26.A, Problem 2SQP
Textbook Problem
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Consider an economy in equilibrium with a recessionary gap. Draw a graph where the equilibrium real GDP is $8 trillion and the price level of 150. Label this equilibrium E1 where the aggregate demand, AD1, intersects the short-run aggregate supply curve (SRAS1). Include in your graph a long-run aggregate supply curve (LRAS) at the full-employment Real GDP level of, say, $12 trillion.

  1. a. From a keynesian perspective, what should government do with its fiscal and monetary policies to achieve full employment? How is this expansionary policy reflected in terms of the aggregate demand curve? Illustrate this in your graph.
  2. b. Illustrate long-run equilibrium on your graph as E2. What has happened to real GDP and the price level as a result of Keynesian policy to achieve full employment in this long run?

(a)

To determine

Economy in equilibrium with recessionary gap.

Explanation of Solution

Classical theory and Keynesian theory:

Figure 1, (a) and (b) illustrates classical and Keynesian theories, respectively. The horizontal axis indicates the real GDP of the economy and the vertical axis indicates the general price level.

In part (a), the economy is at short-run equilibrium level E1, where the real GDP is $8 trillion and the price level is 150. However, the economy is in full employment level at E2, where the real GDP is at $12 trillion. Therefore, the economy would experience a recessionary gap. However, the classicals assume self-correcting mechanism in the economy where full employment can be achieved automatically and also, they assume nominal rate and price flexibility.

In Figure 1, part (b) shows Keynesian theory...

(a)

To determine

Long-run equilibrium.

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Chapter 26 Solutions

Economics For Today
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Ch. 26.A - Assume the economy is operating at a real GDP...Ch. 26.A - Assume the economy is experiencing an inflationary...Ch. 26.A - Assume the economy is in short-run equilibrium at...Ch. 26.A - A policy to do nothing and allow the economy to...Ch. 26.A - Assume the economy is experiencing a recessionary...Ch. 26.A - Assuming the economy is in a recession, Keynesian...Ch. 26.A - Assume the economy is in short-run equilibrium at...Ch. 26.A - Assume the economy is experiencing an inflationary...Ch. 26.A - In part (a) of Exhibit A-3, the economy is...Ch. 26.A - Assume that the economy depicted in part (a) of...Ch. 26.A - In part (b) of Exhibit A-3, the economy is...Ch. 26.A - Assume that the economy depicted in part (b) of...Ch. 26 - How much money do you keep in cash or checkable...Ch. 26 - What are the basic motives for the transactions...Ch. 26 - Suppose a bond pays annual interest of 80. Compute...Ch. 26 - Using the demand and supply schedule for money...Ch. 26 - Assume you are the chair of the Federal Reserve...Ch. 26 - A monetarist investigator might say that the sewer...Ch. 26 - What is the quantity theory of money, and what...Ch. 26 - Exhibit 6 shows the monetarist monetary policy...Ch. 26 - Explain the difference between the Keynesian and...Ch. 26 - Based on the quantity theory of money, what would...Ch. 26 - Suppose the investment demand curve is a vertical...Ch. 26 - Why is the shape of the aggregate supply curve...Ch. 26 - The demand for money that households keep for...Ch. 26 - The quantity of money held in response to interest...Ch. 26 - The speculative demand for money a. varies...Ch. 26 - Other things being equal, the quantity of money...Ch. 26 - A decrease in the interest rate, other things...Ch. 26 - Which of the following statements is true? a. The...Ch. 26 - In Exhibit 11, assume an equilibrium with an...Ch. 26 - According to Keynesians, an increase in the money...Ch. 26 - While the classicists believed that both velocity...Ch. 26 - In Exhibit 12, when the money supply increases...Ch. 26 - In Exhibit 12, if the interest rate falls from i1...Ch. 26 - In Exhibit 12, a shift in aggregate demand from...Ch. 26 - The monetarist transmission mechanism through...Ch. 26 - The equation of exchange states a. MV = PQ. b. MP...Ch. 26 - The quantity theory of money assumes that the...Ch. 26 - The transactions demand for money is the demand...Ch. 26 - People react to an excess supply of money by a....Ch. 26 - The belief that the velocity of money is not...Ch. 26 - The monetary rule is the view of the a. Keynesians...Ch. 26 - Which of the following statements is true? a....

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