If a shock results in a positive output gap and the government's policy choice is to do nothing
A)the government will immediately implement expansionary fiscal policy.
B)the central bank will immediately increase the money supply and close the output gap.
C)it will be detrimental to the economy.
D)the economy will be prevented from returning to equilibrium.
E)the price level will fall, the interest rate will fall, and output will rise, closing the gap.

Question

Quizplus · Accepted Answer

A positive output gap means that actual output is higher than potential output. This could result in lower prices because of excess supply in the market. In this case, doing nothing would be the best option as the economy would naturally correct itself. Lower prices would lead to lower interest rates, which would stimulate investment and consumption, leading to output increasing and closing the gap between actual and potential output. Therefore, option E is the best choice as it explains how the economy would return to equilibrium without any intervention.

If a Shock Results in a Positive Output Gap and the Government's