Refer to the accompanying figure. An economy is currently in long-run equilibrium at point B, at an inflation rate of π', which is too high for to sustain economic growth. If an anti-inflationary policy is enacted, the economy will be in short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________.
A)A; B
B)A; C
C)B; A
D)B; C

Question

Refer to the accompanying figure.  An economy is currently in long-run equilibrium at point B, at an inflation rate of π', which is too high for to sustain economic growth. If an anti-inflationary policy is enacted, the economy will be in short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________.
A)A; B 
B)A; C 
C)B; A 
D)B; C

Quizplus · Accepted Answer

In order for policymakers to reduce inflation, they must tighten monetary policy by shifting its policy reaction function upward, which shifts aggregate demand left. This new short-run equilibrium will exist at point A, where the economy is experiencing a recessionary gap. As a result of this recessionary gap, inflation will gradually start to decrease - shifting the SRAS line downward. When inflation has fallen enough, the economy is back in long-run equilibrium at C.

Refer to the Accompanying Figure