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Figure: Fiscal Policy Options
-(Figure: Fiscal Policy Options) Look at the figure Fiscal Policy Options. If the aggregate demand curve is ADʺ, the most appropriate discretionary fiscal policy is to _____ government transfer payments and _____ income tax rates.
A)decrease; increase
B)decrease; decrease
C)increase; maintain
D)increase; decrease

Question

Use the following to answer questions:
Figure: Fiscal Policy Options 
-(Figure: Fiscal Policy Options) Look at the figure Fiscal Policy Options. If the aggregate demand curve is ADʺ, the most appropriate discretionary fiscal policy is to _____ government transfer payments and _____ income tax rates.
A)decrease; increase 
B)decrease; decrease 
C)increase; maintain 
D)increase; decrease

Quizplus · Accepted Answer

When the aggregate demand curve is ADʺ, there is an inflationary gap. To address this, the most appropriate discretionary fiscal policy is to decrease government transfer payments and increase income tax rates. Decreasing transfer payments will reduce disposable income and decrease consumption, reducing AD. Increasing income tax rates will reduce disposable income and reduce investment, also reducing AD. Together, these policies will help to bring AD back in line with potential output and close the inflationary gap.

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