The diagram below shows an AD/AS model for a hypothetical economy which is initially in a short-run equilibrium at point A. FIGURE 24-6 Refer to Figure 24-6.The government could close the existing output gap by
A)increasing the net tax rate.
B)decreasing the net tax rate.
C)decreasing government purchases.
D)decreasing government transfer payments.
E)implementing a contractionary fiscal policy.

Question

The diagram below shows an AD/AS model for a hypothetical economy which is initially in a short-run equilibrium at point A.  FIGURE 24-6 Refer to Figure 24-6.The government could close the existing output gap by
A)increasing the net tax rate. 
B)decreasing the net tax rate. 
C)decreasing government purchases. 
D)decreasing government transfer payments. 
E)implementing a contractionary fiscal policy.

Quizplus · Accepted Answer

The economy is currently in a short-run equilibrium at point A, where the aggregate demand (AD) curve intersects the short-run aggregate supply (SRAS) curve. However, output is below potential GDP, indicating a negative output gap. To close this output gap and increase output to potential GDP level, the AD curve needs to shift to the right. One way to achieve this is by decreasing the net tax rate, which would increase disposable income and consumer spending, thereby increasing aggregate demand. Therefore, the best choice is B. Increasing the net tax rate (choice A) would decrease disposable income and reduce consumer spending, leading to a contraction in aggregate demand, worsening the output gap. Decreasing government purchases (choice C) would reduce government spending, leading to a decrease in aggregate demand and worsening the output gap. Decreasing government transfer payments (choice D) would decrease disposable income for recipients of transfer payments, leading to a decrease in consumer spending and aggregate demand, worsening the output gap. Implementing a contractionary fiscal policy (choice E) would involve a combination of decreasing government spending and increasing taxes, which would lead to a decrease in aggregate demand and worsening of the output gap.

The Diagram Below Shows an AD/AS Model for a Hypothetical