Related to the Economics in Practice on p. 238: An earthquake destroyed 50% of the Moldovian manufacturing base. The Moldovian government decided to use a contractionary fiscal policy to counter the effects of the earthquake on the economy. The use of the contractionary fiscal policy would have caused
A) the price level to be lower and the output level to be higher than they would have been without the policy action.
B) both the price level and the output level to be higher than they would have been without the policy action.
C) both the price level and output level to be lower than what they would have been without the policy action.
D) the price level to be higher and the output level to be lower than they would have been without the policy action.

Question

Quizplus · Accepted Answer

Contractionary fiscal policy involves decreasing government spending and/or increasing taxes, which leads to a decrease in aggregate demand. In this case, Moldova is already facing a decrease in the manufacturing base due to the earthquake, which means that the aggregate supply has also decreased. The contractionary fiscal policy would lead to a further decrease in aggregate demand and hence, a decrease in both price level and output level compared to what they would have been without the policy action. Therefore, option C is correct.

Related to the Economics in Practice on P