FIGURE 24-1 -Refer to Figure 24-1.Suppose the economy is currently in a short-run equilibrium with output of Y₀.An appropriate fiscal policy response,to attain potential output (Y^*),is A)an increase in personal income taxes. B)a reduction in government purchases of goods and services. C)an increase in corporate income taxes. D)an increase in government purchases. E)an increase in interest rates to encourage increased saving.

Question

Quizplus · Accepted Answer

To achieve potential output, the economy needs to shift from Y₀ to Y^*. This requires an increase in aggregate demand, and the most effective fiscal policy response to increase aggregate demand is through an increase in government purchases. Therefore, the correct choice is D. An increase in taxes reduces disposable income and decreases consumption, while an increase in interest rates discourages investment and consumption. A reduction in government purchases would decrease aggregate demand and worsen the recession. An increase in corporate income taxes could decrease investment and worsen the recession, while also reducing aggregate supply in the long run.

FIGURE 24-1 -Refer to Figure 24-1.Suppose the Economy Is Currently in a in a Short-Run