If potential output equals 10200 and short-run equilibrium output equals 9700,there is a(n) gap and the Reserve Bank must_____real interest rates in order to close the gap. ○expansionary;:raise O contractionary;raise O expansionary;lower O expansionary;not change O contractionary;lower
Question
If potential output equals 10200 and short-run equilibrium output equals 9700,there is a(n) gap and the Reserve Bank must_____real interest rates in order to close the gap. ○expansionary;:raise O contractionary;raise O expansionary;lower O expansionary;not change O contractionary;lower
Solution 1
No answer
Solution 2
The correct answer is:
O contractionary; lower
Here's why:
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First, we need to understand the terms. Potential output is the highest level of economic output an economy can sustainably produce using existing production processes and resources. Short-run equilibrium output is the level of output where the quantity of output firms wish to produce equals the quantity consumers wish to buy.
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In this case, potential output (10200) is greater than short-run equilibrium output (9700). This means the economy is not producing at its full capacity and there is a contractionary gap.
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The Reserve Bank can close this gap by encouraging economic activity. One way to do this is by lowering real interest rates. Lower interest rates make borrowing cheaper, encouraging businesses to invest and consumers to spend, which increases economic output.
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