Refer to the graph. Assume that the economy is in a recession with a price level of $P _ { 1 }$ and output level
$Q _ { 1 }$ . The government then adopts an appropriate discretionary ?scal policy. What will be the most likely
New equilibrium price level and output?

Question

Quizplus · Accepted Answer

In a recession, the output level is below the potential output level, which is indicated by the LRAS curve. Therefore, to increase output, the government should adopt an expansionary fiscal policy. This can be done by increasing government spending or decreasing taxes, which will shift the AD curve to the right. The new equilibrium point will be at a higher output level and a higher price level, which is represented by point C ($P _ { 2 }$ and $Q _ { 2 }$). Option A is incorrect because point D ($P _ { 2 }$ and $Q _ { 4 }$) is not attainable with the given information. Option B is incorrect as the question asks for the new equilibrium point after the government adopts a discretionary fiscal policy. Option D is incorrect as the increase in output is too large to be achieved with a discretionary fiscal policy.

Refer to the Graph P1P _ { 1 }P1​ And Output Level

Refer to the Graph $P _ { 1 }$ And Output Level