Aggregate Demand and Supply Analysis
-In the figure above,assume that output is $10.5 trillion,while potential output is $12 trillion.Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves,as shown in the figure,while monetary policy sets the real interest rate at one percent.If the short-run aggregate supply curve is π =
Y - 13,then the resulting values of output and inflation are ________.
A)$12 trillion & 3 percent
B)$13.5 trillion & 5 percent
C)$9.75 trillion & 0 percent
D)$13.5 trillion & 0 percent
E)$12.5 trillion & 2 percent

Question

Aggregate Demand and Supply Analysis 
-In the figure above,assume that output is $10.5 trillion,while potential output is $12 trillion.Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves,as shown in the figure,while monetary policy sets the real interest rate at one percent.If the short-run aggregate supply curve is π = 
Y - 13,then the resulting values of output and inflation are ________.
A)$12 trillion & 3 percent 
B)$13.5 trillion & 5 percent 
C)$9.75 trillion & 0 percent 
D)$13.5 trillion & 0 percent 
E)$12.5 trillion & 2 percent

Quizplus · Accepted Answer

The fiscal stimulus and recovery of consumer and business confidence will shift both the IS and AD curves to the right, leading to an increase in output and inflation. The monetary policy setting the real interest rate at one percent will further stimulate the economy.

Using the SRAS equation:
π = Y - 13
π = $10.5 trillion - $13 billion
π = -$2.5 billion (which is negative inflation)

We can see that the current output level of $10.5 trillion is below potential output of $12 trillion. As the AD and IS curves shift to the right, equilibrium output will increase towards potential output.

From the graph, we can estimate the new equilibrium point at approximately $13.5 trillion of output with a 5% inflation rate. Therefore, the correct answer is B.