-Refer to Figure 11.2. The economy is currently at AD₁. If the government's fiscal policy objective is to stabilize GDP at Y_P, the government should: A) reduce the structural primary budget balance by changing expenditure and taxes to shift the AD to the left. B) change taxes and expenditure to move the economy to the left along the BB function and lower AD. C) increase the structural primary budget balance by increasing taxes and /or cutting expenditures to shift the AD to the left. D) allow the automatic fiscal stabilization reflected in the slope of the BB line to establish equilibrium at Y_P.

Question

Quizplus · Accepted Answer

To stabilize GDP at the desired level, the government needs to decrease aggregate demand (AD) if the economy is overheating. Increasing taxes and/or cutting expenditures will reduce the aggregate demand by reducing disposable income and government spending, thus shifting the AD curve to the left.