Figure 17-7

-Refer to Figure 17-7.Suppose the economy is in short-run equilibrium above potential GDP,the unemployment rate is very low,and wages and prices are rising.Using the static AD-AS model in the figure above,the correct Fed policy for this situation would be depicted as a movement from

Question

Figure 17-7
 
-Refer to Figure 17-7.Suppose the economy is in short-run equilibrium above potential GDP,the unemployment rate is very low,and wages and prices are rising.Using the static AD-AS model in the figure above,the correct Fed policy for this situation would be depicted as a movement from

Quizplus · Accepted Answer

Since the economy is above potential GDP, wages and prices are rising indicating an overheated economy. This scenario calls for contractionary monetary policy to slow down the economy and bring it back to potential GDP. The correct Fed policy is to decrease aggregate demand, which can be achieved by increasing interest rates. This is depicted as a movement from point C (short-run equilibrium above potential GDP) to point B (short-run equilibrium at potential GDP with lower price level).

Figure 17-7 -Refer to Figure 17-7.Suppose the Economy Is in Short-Run Equilibrium