Based on the figure below. An economy in short-run equilibrium at point A has a(n) _______ gap. The gap could be eliminated by the self-correcting mechanism of the economy and eventually achieve long-run equilibrium at point ____ or the central bank could intervene with monetary easing establishing the long-run equilibrium at point ____.
A) recessionary; B; C
B) recessionary; C; B
C) expansionary; C; B
D) expansionary; B; C

Question

Based on the figure below. An economy in short-run equilibrium at point A has a(n) _______ gap. The gap could be eliminated by the self-correcting mechanism of the economy and eventually achieve long-run equilibrium at point ____ or the central bank could intervene with monetary easing establishing the long-run equilibrium at point ____. 
A) recessionary; B; C 
B) recessionary; C; B 
C) expansionary; C; B 
D) expansionary; B; C

Quizplus · Accepted Answer

Since the short-run equilibrium level of output is below the potential level of output, the economy is experiencing a recessionary output gap. The self-correcting mechanism of the economy means that inflation will gradually start to decrease in response to the recessionary gap - shifting the SRAS line downward. When inflation has fallen enough, the economy is back in long-run equilibrium at point C. If instead the central bank intervenes with monetary easing, shifting down its policy reaction function, aggregate demand will shift right to AD¹ establishing the long-run equilibrium at point B where inflation remains at the higher level.

Based on the Figure Below