Exhibit 20A-2 Macro AD/AS Models

-In Panel (a)of Exhibit 20A-2,the economy is initially in short-run equilibrium at real GDP level Y₁ and price level P₂.If the federal government or Fed decides to intervene,it would most likely:
A) increase taxes.
B) decrease the money supply.
C) increase the level of government spending for goods and services.
D) decrease the level of government spending for goods and services.

Question

Exhibit 20A-2 Macro AD/AS Models
 
-In Panel (a)of Exhibit 20A-2,the economy is initially in short-run equilibrium at real GDP level Y₁ and price level P₂.If the federal government or Fed decides to intervene,it would most likely:
A) increase taxes. 
B) decrease the money supply. 
C) increase the level of government spending for goods and services. 
D) decrease the level of government spending for goods and services.

Quizplus · Accepted Answer

In Panel (a), the economy is experiencing a recessionary gap with output Y₁ below potential output Yp. To close this gap and shift the aggregate demand curve to the right, the government or Fed can increase the level of government spending for goods and services. This would directly increase aggregate demand and result in higher output and prices. Therefore, choice (C) is the best option. Increasing taxes or decreasing the money supply would further decrease aggregate demand and worsen the recession, while decreasing government spending would exacerbate the recessionary gap by reducing aggregate demand.