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Figure: Short- and Long-Run Equilibrium
-(Figure: Short- and Long-Run Equilibrium) Look at the figure Short- and Long-Run Equilibrium. If the economy is at equilibrium at E₁, the government should use _____ fiscal policy to shift the aggregate demand curve to the _____ .

Question

Use the following to answer questions :
Figure: Short- and Long-Run Equilibrium

-(Figure: Short- and Long-Run Equilibrium) Look at the figure Short- and Long-Run Equilibrium. If the economy is at equilibrium at E₁, the government should use _____ fiscal policy to shift the aggregate demand curve to the _____ .

Quizplus · Accepted Answer

If the economy is at equilibrium at E₁, it is operating below potential GDP. To close the output gap and raise GDP to potential, the government should use expansionary fiscal policy, such as increasing government spending or cutting taxes, to shift the aggregate demand curve to the right. This will lead to an increase in both equilibrium output and prices in the short and long run.

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