Currently a small economy is producing real GDP of $400 Billion ($400,000,000,000). Economists estimate that this economy has a full employment rate of output of $450 Billion ($450,000,000,000). The marginal propensity to save (mps) is 20% economy, and the government is currently operating with a balanced budget.

1.Draw an AD/AS model showing the current output and the full employment level of output. Use $400B and $450B as abbreviations for output rather than Y1 and Yf.

2.Is there a recessionary gap or an expansionary gap? What is the size of the gap?

3.Is the current rate of unemployment below the natural rate of unemployment, above the natural rate of unemployment, or equal to the natural rate of unemployment? Why?

4.Calculate the marginal propensity to consume.

5.Calculate the government spending multiplier.

6.Calculate the tax multiplier.

7.If the government increases spending by $50 billion without increasing taxes, how much will GDP increase?

8.How much will the government need to increase government spending in order to eliminate the output gap?

9.Now suppose instead of what happened in #7, the government increases spending by $10 billion, but also raises taxes by $10 billion so that they keep a balanced budget. Will GDP still increase? Explain.