Question 7

7. Use of discretionary policy to stabilize the economy Should the government use monetary and fiscal policy in an effort to stabilize the economy? The following questions address the issue of how monetary and fiscal policies affect the economy, as well as the pros and cons of using these tools to combat economic fluctuations. The following graph plots hypothetical aggregate demand (AD), short-run aggregate supply (AS), and long-run aggregate supply (LRAS) curves for the U.S. economy in February 2026. Suppose the government chooses to intervene in order to return the economy to the natural level of output by using policy. Depending on which curve is affected by the government policy, shift either the AS curve or the AD curve to reflect the change that would successfully restore the natural level of output 150 O AS 130 AD 110 AS PRICE LEVEL 90 AD 70 LRAS 22 24 26 28 30 OUTPUT (Trillions of dollars) Suppose that in February 2026 the government successfully carries out the type of policy necessary to restore the natural level of output described in the previous question. In July 2026, U.S. exports decrease because Europe implements trade restrictions on U.S. goods. Due to the associated with implementing monetary and fiscal policy, the impact of the government's new policy will likely once the effects of the policy are fully realized. Grade It Now Save & Continue8. Using policy to stabilize the economy The government possesses the tools necessary to influence the output level in the short run through use of monetary and fiscal policy. However, there is some debate regarding whether the government should attempt to stabilize the economy. Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply. O The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates. Businesses make investment plans many months in advance. The current tax system acts as an automatic stabilizer. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. Which of the following policies are examples of automatic stabilizers? Check all that apply. O Unemployment insurance benefits Personal income taxes O The discount rate Grade It Now Save & Continue Continue without saving