Use the following to answer questions: Figure: Inflationary and Recessionary Gaps -(Figure: Inflationary and Recessionary Gaps) Refer to Figure: Inflationary and Recessionary Gaps. If the economy is in short-run equilibrium at Y₁ in panel (b), a contractionary policy to bring the economy back to potential output at Y_P would attempt to shift the: A) SRAS to the left. B) LRAS to the left. C) aggregate demand curve to the left by decreasing aggregate demand. D) aggregate demand curve to the right by increasing aggregate demand.

Question

Quizplus · Accepted Answer

Since the economy is in a short-run equilibrium at Y₁, the output is greater than the potential output, causing an inflationary gap. To bring the economy back to potential output at Y_P, a contractionary policy is required. This means decreasing the aggregate demand curve, which can be achieved by decreasing government spending, increasing taxes, or decreasing the money supply. Therefore, the correct choice is C: Aggregate demand curve to the left by decreasing aggregate demand.

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