Refer to the graphs below.The first graph shows the money market of an economy, and the second graph shows the market for goods and services in the economy. In the above diagrams, the numbers in the parentheses after the AD₁, AD₂, and AD₃ labels indicate the levels of investment spending associated with each AD curve.All figures are in billions.Q_f is the full-employment level of real output.The interest rate in the economy is 4 percent.Which of the following should the monetary authorities do to achieve a non-inflationary full-employment level of real GDP? A)They should increase the money supply from $75 billion to $225 billion. B)They should decrease the money supply by $150 billion. C)They should decrease the money supply from $225 billion to $150 billion. D)They should increase the money supply by $200 billion.

Question

Quizplus · Accepted Answer

To achieve a non-inflationary full-employment level of real GDP, the economy should produce Q_f level of output. In the given graphs, AD1 shows an equilibrium level of output higher than Q_f, indicating an inflationary gap. To close this gap, the AD curve needs to shift to the left. This can be achieved by decreasing the money supply. Option C shows a decrease in the money supply from $225 billion to $150 billion, which will shift the AD curve to the left and reach the full-employment level of output without causing inflation. Options A and D both involve an increase in the money supply, which will shift the AD curve to the right and worsen the inflationary gap. Option B involves a decrease in the money supply by too large an amount, which could cause a recession and lead to unemployment.

Refer to the Graphs Below