Based on the situation depicted in the graph below, which of the following would be an appropriate fiscal policy response?

Question

Quizplus · Accepted Answer

The graph shows an economy operating above its potential output (full employment), which is indicated by the output gap being positive. To close the output gap and bring the economy back to full employment, the appropriate fiscal policy response would be to decrease government purchases and increase taxes. Decreasing government purchases would reduce aggregate demand, while increasing taxes would reduce disposable income, leading to a decrease in consumption, and ultimately resulting in a decrease in aggregate demand. Therefore, option D (both A and C above) would be the best choice.

Based on the Situation Depicted in the Graph Below, Which