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Figure: AD-AS
-(Figure: AD-AS) Look at the figure AD-AS. Suppose the economy is producing the output level Y_p and a negative demand shock shifts the AD₁ curve to AD₃. The economy now has a(n) _____ gap, which can be closed by _____ fiscal policy.

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Figure: AD-AS

-(Figure: AD-AS) Look at the figure AD-AS. Suppose the economy is producing the output level Y_p and a negative demand shock shifts the AD₁ curve to AD₃. The economy now has a(n) _____ gap, which can be closed by _____ fiscal policy.

Quizplus · Accepted Answer

The negative demand shock shifts the AD curve leftward, leading to a lower output level (Y) and higher unemployment (U), resulting in a recessionary gap. To close this gap, expansionary fiscal policy is needed, i.e., an increase in government spending or reduction in taxes to stimulate demand and shift the AD curve back to the right. Therefore, option C is the correct answer. Options A and D are incorrect because inflationary gaps occur when aggregate demand exceeds aggregate supply, and contractionary fiscal policy is required to reduce demand and shift the AD curve leftward. Option B is incorrect because recessionary gap needs expansionary, not contractionary, fiscal policy to stimulate demand and reduce unemployment.

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