FRQ Practice for Grade Bump (2 of 2 Short FRQs)

Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to “Calculate,” you must show how you arrived at your final answer.

An economy is currently in short-run equilibrium with a recessionary output gap of $600 billion.

Draw a single correctly labeled graph with both the short-run and long-run Phillips curves. Label the initial short-run equilibrium point X.

Suppose the government implements fiscal policy in order to achieve full-employment output and the marginal propensity to consume is 0.75.

(i) Calculate the minimum change in government spending required to increase aggregate demand by the amount of the output gap of $600 billion. Show your work.

(ii) Suppose instead the government wants to change taxes rather than government spending. Calculate the minimum change in taxes required to increase aggregate demand by the amount of the output gap of $600 billion. Show your work.

Assume instead the government takes no policy action to close the output gap shown in part (a). Explain how the economy will adjust in the long run.