The economy in Country X is in a recession, with real gross domestic product (GDP) $100 billion below full- employment output.
1. (a) Draw one correctly labeled graph of the short-run and long-run Phillips curves, labeling the
current equilibrium point A.
2. (b) Assume that the government increases spending by $20 billion to stimulate economic activity.
Assume that the marginal propensity to save is 0.25. Calculate the maximum total change in real GDP
that could occur following the $20 billion increase in government spending.
3. (c) On your graph in part (a), label the new equilibrium point B as a result of the increase in
government spending.
4. (d) Had the government lowered personal income taxes by $20 billion instead of increasing spending
by $20 billion, would the maximum total change in real GDP be greater than, smaller than, or the
same as the one calculated in part (b)? Explain.