Refer to Figure 10.3.If full-employment GDP is $500 billion and the economy is on AD₀, A)An inflationary gap exists,and AD must decrease by less than $100 billion to eliminate it. B)A recessionary gap exists,and AD must increase by more than $100 billion to eliminate it. C)An inflationary gap exists,and AD must increase by $100 billion to eliminate it. D)An inflationary gap exists,and AD must decrease by more than $100 billion to eliminate it.

Question

Quizplus · Accepted Answer

The economy is currently producing above full-employment GDP, indicating an inflationary gap. To eliminate the gap, aggregate demand must decrease to bring the economy back to its potential output level. The vertical distance between ADS1 and the full-employment GDP line represents the size of the inflationary gap, which is greater than $100 billion. Thus, AD must decrease by more than $100 billion to eliminate the gap, making choice D the correct answer.