FIGURE 24-1 Refer to Figure 24-1.Suppose the economy is currently in a short-run equilibrium with output of Y₀.An appropriate fiscal policy response,to attain potential output (Y^*),is A)an increase in personal income taxes. B)a reduction in government purchases of goods and services. C)an increase in corporate income taxes. D)an increase in government purchases. E)an increase in interest rates to encourage increased saving.

Question

Quizplus · Accepted Answer

To attain potential output, the economy needs a fiscal policy response that increases aggregate demand. Thus, an increase in government purchases would be the best choice as it directly increases aggregate demand and shifts the aggregate demand curve to the right towards potential output. On the other hand, options A, B, and C all involve decreasing aggregate demand, which would push the economy further away from potential output. Option E, increasing interest rates, would lead to a decrease in consumption and investment spending, which would also decrease aggregate demand and move the economy further away from potential output.