The three figures below show the phases of a disinflation.In part (i),the economy is experiencing a sustained inflation at E₁. FIGURE 29-4 Refer to Figure 29-4,part (iii).Consider the recovery phase of the disinflation process when output is returning from Y₃ to Y*.Real GDP can return to potential either by ________,or by ________.

Question

Quizplus · Accepted Answer

In order for real GDP to return to potential, either the AS curve must shift back to its potential level (AS₂) or the AD curve must shift back to its pre-disinflation level (AD₂). Option B is the best choice because it suggests that the AS curve will fall slowly back to its potential level, which would cause prices to decrease and output to increase. Additionally, a monetary expansion would shift the AD curve back to its pre-disinflation level, further increasing output. The other options either involve unrealistic policy choices, such as legislating a wage-and-price freeze, or do not address both the AS and AD curves.

The Three Figures Below Show the Phases of a Disinflation