The figure given below depicts short-run equilibrium in an aggregate demand-aggregate supply model.If the economy is at point "e" in the short run,which of these policies adopted by the Fed is likely to return it to long-run equilibrium?
Figure 15.3

A)A decrease in government spending
B)An increase in the tax rate
C)A decrease in the tax rate
D)A decrease in the money supply
E)An increase in the money supply

Question

​The figure given below depicts short-run equilibrium in an aggregate demand-aggregate supply model.If the economy is at point "e" in the short run,which of these policies adopted by the Fed is likely to return it to long-run equilibrium? ​
Figure 15.3

A)A decrease in government spending 
B)An increase in the tax rate 
C)A decrease in the tax rate 
D)A decrease in the money supply 
E)An increase in the money supply

Quizplus · Accepted Answer

In the short-run equilibrium shown in the figure, the economy is producing output higher than the potential output, and the price level is also higher than the expected level in the long-run equilibrium. This suggests that the economy is facing an inflationary gap. To return the economy to the long-run equilibrium, the Fed needs to adopt a contractionary monetary policy, which involves decreasing the money supply. This will increase the interest rates, decrease investment and consumption expenditure, lower aggregate demand, and eventually reduce output and prices to their long-run equilibrium levels. Therefore, option D is the correct choice. Option A is incorrect because decreasing government spending will also decrease aggregate demand, but it may not be enough to return the economy to the long-run equilibrium. Options B and C are incorrect because changing the tax rates will mainly affect households' disposable income, but it may not have a significant impact on aggregate demand and supply.

​The Figure Given Below Depicts Short-Run Equilibrium in an Aggregate

The Figure Given Below Depicts Short-Run Equilibrium in an Aggregate