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Figure: Short- and Long-Run Equilibrium II
-(Figure: Short- and Long-Run Equilibrium II) Look at the figure Short- and Long-Run Equilibrium II. If the economy is at equilibrium at E₁, the appropriate policy to return the economy to potential output would be a(n) :

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Figure: Short- and Long-Run Equilibrium II

-(Figure: Short- and Long-Run Equilibrium II) Look at the figure Short- and Long-Run Equilibrium II. If the economy is at equilibrium at E₁, the appropriate policy to return the economy to potential output would be a(n) :

Quizplus · Accepted Answer

The economy is currently producing below potential output, as indicated by the vertical distance between the long-run aggregate supply (LRAS) curve and the equilibrium point. This indicates that there is slack in the economy, and that resources are underutilized. To return the economy to potential output, it is necessary to decrease aggregate demand, which will shift the aggregate demand (AD) curve to the left, leading to a lower equilibrium output level. A decrease in government spending is the appropriate policy option, as it directly reduces aggregate demand. The other policy options (increase in government spending, increase in transfer payments, or decrease in taxes) would all increase aggregate demand and exacerbate the existing gap between actual and potential output.

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