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Figure: AD-AS Model I
-(Figure: AD-AS Model I) Refer to Figure: AD-AS Model I. If the economy is at point X, the appropriate fiscal policy is to:
A) increase taxes and decrease government spending.
B) decrease taxes and increase government spending.
C) increase the money supply and interest rates.
D) decrease the money supply and interest rates.

Question

Use the following to answer questions:
Figure: AD-AS Model I 
-(Figure: AD-AS Model I) Refer to Figure: AD-AS Model I. If the economy is at point X, the appropriate fiscal policy is to:
A) increase taxes and decrease government spending. 
B) decrease taxes and increase government spending. 
C) increase the money supply and interest rates. 
D) decrease the money supply and interest rates.

Quizplus · Accepted Answer

At point X, the economy is experiencing a recessionary gap, with output lower than potential GDP. To close the gap and increase output, the appropriate fiscal policy would be expansionary, meaning a decrease in taxes and an increase in government spending. This would shift the aggregate demand curve to the right, leading to higher output and a higher price level. Option A would have the opposite effect, decreasing aggregate demand and worsening the recession. Options C and D relate to monetary policy, not fiscal policy, and are not appropriate for closing a recessionary gap.

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