Figure 11.1 shows the relationship between the price level and the real GDP.Which of the following sets of policies would unambiguously move the economy to full employment?

A)Increase in government purchases,increase in taxes,and decrease in transfer payments
B)Decrease in government purchases,increase in taxes,and decrease in transfer payments
C)Increase in government purchases,decrease in taxes,and increase in transfer payments
D)Increase in government purchases,increase in taxes,and increase in transfer payments
E)Decrease in government purchases,decrease in taxes,and decrease in transfer payments

Question

Figure 11.1 shows the relationship between the price level and the real GDP.Which of the following sets of policies would unambiguously move the economy to full employment?

A)Increase in government purchases,increase in taxes,and decrease in transfer payments 
B)Decrease in government purchases,increase in taxes,and decrease in transfer payments 
C)Increase in government purchases,decrease in taxes,and increase in transfer payments 
D)Increase in government purchases,increase in taxes,and increase in transfer payments 
E)Decrease in government purchases,decrease in taxes,and decrease in transfer payments

Quizplus · Accepted Answer

The figure shows that the economy is currently operating below full employment (where the potential GDP intersects with the 45-degree line). To move the economy to full employment, policy measures should increase aggregate demand, shift the AD curve to the right, and increase output. Among the given options, increasing government purchases, decreasing taxes, and increasing transfer payments would increase aggregate demand and shift the AD curve to the right. Decreasing taxes alone, as in option B, may increase consumption and output in the short run but may not be enough to bring the economy to full employment in the long run. Decreasing government purchases and transfer payments, and increasing taxes together, as in option B, may have a contractionary effect on the economy, shifting the AD curve to the left, decreasing output, and worsening the already existing recessionary gap. Hence, the best choice is C.

Figure 111 Shows the Relationship Between the Price Level and the the Real