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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 monetary policy is to:
A) increase taxes and decrease government spending.
B) decrease taxes and increase government spending.
C) increase the money supply and decrease interest rates.
D) decrease the money supply and increase 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 monetary policy is to:
A) increase taxes and decrease government spending. 
B) decrease taxes and increase government spending. 
C) increase the money supply and decrease interest rates. 
D) decrease the money supply and increase interest rates.

Quizplus · Accepted Answer

At point X, the economy is experiencing a recessionary gap (YF < Y1), which means that the equilibrium output is below the potential output level. To boost the economy, the appropriate monetary policy would be to increase the money supply and decrease interest rates. This would shift the AD curve to the right, leading to an increase in output and employment levels. Choices A and B refer to fiscal policies, which are not the appropriate policy tools in this case. Choice D would further contract the economy by decreasing the money supply and increasing interest rates, aggravating the recessionary gap.

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