Use the following to answer questions: -(Figure: AD-AS) Refer to Figure: AD-AS. Suppose the economy is producing the output level Y_p and a negative demand shock shifts the AD₁ curve to AD₃. The economy now has a(n) _____ gap, which can be closed by _____ fiscal policy. A) inflationary; expansionary B) recessionary; contractionary C) recessionary; expansionary D) inflationary; contractionary

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The negative demand shock will shift the aggregate demand curve to the left, resulting in a decrease in output and increase in unemployment. This creates a recessionary gap. To close this gap, expansionary fiscal policy such as increasing government spending or decreasing taxes can stimulate aggregate demand and shift the AD curve back to the right. Therefore, the best choice is C: recessionary gap, which can be closed by expansionary fiscal policy.

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