Use the following to answer questions: -(Figure: Short- and Long-Run Equilibrium II) Refer to 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): A) increase in government spending. B) decrease in government spending. C) increase in transfer payments. D) decrease in taxes.

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The economy is currently operating above potential output, as output is above the long-run aggregate supply curve. This indicates that aggregate demand is too high. To return the economy to potential output, aggregate demand must be decreased. The appropriate policy to achieve this goal is to decrease government spending, which will decrease aggregate demand and shift the AD curve to the left.

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