Refer to Figure 26-5.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
A) A to B.
B) B to C.
C) C to B.
D) A to E.
E) C to D.

Question

Quizplus · Accepted Answer

The economy is already above potential GDP, which implies inflationary pressure. Furthermore, unemployment is low and wages and prices are rising, indicating that the economy is overheating. To cool down the economy and reduce inflationary pressure, the Fed should pursue a contractionary monetary policy, which involves reducing the money supply and increasing interest rates. This is depicted as a movement along the AD curve from point C to point B, leading to a decrease in output and higher prices. Therefore, choice C is the correct answer.