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Figure: Monetary Policy and the AD-SRAS Model
-(Figure: Monetary Policy and the AD-SRAS Model) Refer to Figure: Monetary Policy and the AD-SRAS Model. If the economy is in an inflationary gap at point h, it can move to point i as a result of:
A) an increase in the money supply.
B) a reduction in the discount rate.
C) a decrease in the money supply.
D) purchases of government securities in the open market.

Question

Use the following to answer questions:
Figure: Monetary Policy and the AD-SRAS Model 
-(Figure: Monetary Policy and the AD-SRAS Model) Refer to Figure: Monetary Policy and the AD-SRAS Model. If the economy is in an inflationary gap at point h, it can move to point i as a result of:
A) an increase in the money supply. 
B) a reduction in the discount rate. 
C) a decrease in the money supply. 
D) purchases of government securities in the open market.

Quizplus · Accepted Answer

In an inflationary gap, there is upward pressure on prices and decreasing aggregate demand is necessary to return to potential output. A decrease in the money supply would increase interest rates, decrease consumer spending and investment, and shift the aggregate demand curve leftward, leading to a movement from h to i. The other choices would result in an increase in aggregate demand, exacerbating inflationary pressures.

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