Refer to the accompanying figure. An economy in short-run equilibrium at point A has a(n)________ gap. The gap could be eliminated by the self-correcting mechanism of the economy and eventually achieve long-run equilibrium at point ________ or the central bank could intervene with monetary easing establishing the long-run equilibrium at point ________.
A)recessionary; B; C
B)recessionary; C; B
C)expansionary; C; B
D)expansionary; B; C

Question

Refer to the accompanying figure.  An economy in short-run equilibrium at point A has a(n)________ gap. The gap could be eliminated by the self-correcting mechanism of the economy and eventually achieve long-run equilibrium at point ________ or the central bank could intervene with monetary easing establishing the long-run equilibrium at point ________.
A)recessionary; B; C 
B)recessionary; C; B 
C)expansionary; C; B 
D)expansionary; B; C

Quizplus · Accepted Answer

Since the short-run equilibrium level of output is below the potential level of output, the economy is experiencing a recessionary output gap. The self-correcting mechanism of the economy means that inflation will gradually start to decrease in response to the recessionary gap, thereby shifting the SRAS line downward. When inflation has fallen enough, the economy is back in long-run equilibrium at point C. If instead the central bank intervenes with monetary easing, shifting down its policy reaction function, aggregate demand will shift right to AD¹ establishing the long-run equilibrium at point B where inflation remains at the higher level.

Refer to the Accompanying Figure