Exhibit 15.4

-Exhibit 15.4 depicts short-run equilibrium in an aggregate demand-aggregate supply model. The Fed can return the economy to potential output in the long-run by _____

Question

Exhibit 15.4
 
-Exhibit 15.4 depicts short-run equilibrium in an aggregate demand-aggregate supply model. The Fed can return the economy to potential output in the long-run by _____

Quizplus · Accepted Answer

In the short-run equilibrium depicted in Exhibit 15.4, the economy is producing below its potential output, which means there is a recessionary gap. To return the economy to potential output, the Fed needs to increase aggregate demand. One way to do that is by selling U.S. government securities on the open market, which increases interest rates, reduces investment spending, and decreases aggregate demand. This reduction in aggregate demand shifts the aggregate demand curve leftward, causing a decrease in both output and price level. The economy then moves toward the long-run equilibrium, where output is back at potential. Therefore, choice C is the best choice. The other options - purchasing U.S. government securities, decreasing taxes, lowering the discount rate, or lowering the required reserve ratio - would all increase aggregate demand in the short run, exacerbating the inflationary pressures in the economy and pushing it further away from the long-run equilibrium.

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