Figure: Aggregate Demand Shifts 2 Refer to the figure.Suppose the economy is initially at point A in the diagram.If a decrease in investment spending causes a shift of the AD curve from AD₁ to AD₂,then the government can avoid a short-run recession by: A) increasing taxes so that the AD curve shifts back to AD₁. B) increasing taxes so that the AD curve shifts further in to AD₃. C) increasing government spending so that the AD curve shifts back to AD₁. D) increasing government spending so that the AD curve shifts further in to AD₃.

Question

Quizplus · Accepted Answer

An decrease in investment spending would shift the AD curve to the left, causing a short-run recession. To avoid this recession, the government can increase its own spending, which would shift the AD curve to the right and back to its original position (AD₁). Therefore, option C is the best choice. Option D is incorrect because it suggests increasing government spending further than necessary. Option A is incorrect because it suggests increasing taxes, which would further reduce aggregate demand and worsen the recession. Option B is incorrect because it suggests increasing taxes even further, which is also not an effective solution to avoiding a recession.

Figure: Aggregate Demand Shifts 2 Refer to the Figure