Exhibit 15.4

-Exhibit 15.4 depicts short-run equilibrium in an aggregate demand-aggregate supply model. If the economy is at point "e" in the short run, which of these policies adopted by the Fed is likely to return it to long-run equilibrium?

Question

Exhibit 15.4
 
-Exhibit 15.4 depicts short-run equilibrium in an aggregate demand-aggregate supply model. If the economy is at point "e" in the short run, which of these policies adopted by the Fed is likely to return it to long-run equilibrium?

Quizplus · Accepted Answer

In the short run, the economy is at point e which is above the potential output level. To return to the long-run equilibrium, the output level needs to decrease, which can be achieved by decreasing the money supply. This policy will shift the aggregate demand curve to the left, resulting in a decrease in both output and price level, eventually returning the economy to the potential output level in the long run. A decrease in government spending (A), an increase in tax rate (B), and a decrease in tax rate (C) would not directly affect the money supply or the aggregate demand curve, thus they are unlikely to return the economy to long-run equilibrium. An increase in the money supply (E) would exacerbate the inflationary pressure caused by the initial shift in the aggregate demand curve, and therefore not effective in restoring the long-run equilibrium.

Exhibit 15.4 -Exhibit 15.4 Depicts Short-Run Equilibrium in an Aggregate Demand-Aggregate Supply