Exhibit 11-6 Aggregate demand and supply model

In Exhibit 11-6, if the aggregate demand curve is at AD₁, the government should:

Question

Exhibit 11-6 Aggregate demand and supply model In Exhibit 11-6, if the aggregate demand curve is at AD₁, the government should:

Quizplus · Accepted Answer

The current position of the economy is at point U1 on the aggregate demand curve, which indicates a level of output below the potential output. To close this output gap and return to the potential output, the aggregate demand curve needs to shift to the right. This can be achieved by cutting taxes, which would stimulate consumption and investment, and result in an increase in aggregate demand. Cutting spending may also reduce aggregate demand, which is counterproductive in this situation. Raising taxes would have a contractionary effect on the economy and further decrease aggregate demand, making it an inappropriate choice. Cutting taxes to move to AD₂ seems to be the best choice as it shifts the aggregate demand curve rightward, leading to an increase in output and employment without causing inflationary pressures. Moving to AD₃ may cause inflation and overheating of the economy, which is not desirable.

Exhibit 11-6 Aggregate Demand and Supply Model