Question

use the graph to answer the question.
country x’s economic situation is depicted by the graph above. which of the following will happen if country x’s central bank conducts a contractionary monetary policy?
a the economy will be in a recessionary gap; the price level will decrease, and the real output level will increase.
b the economy will be in a recessionary gap; the price level and the real output level will decrease.
c the economy will be at full employment; the price level and the real output level will increase.
d the economy will be in an inflationary gap; the price level and the real output level will increase.
e the economy will be in an inflationary gap; the price level will increase, and the real output level will decrease.

Explanation:

1. Initially, the economy is at full employment, where AD, SRAS, and LRAS intersect, meaning real output equals potential GDP.
2. Contractionary monetary policy reduces the money supply, raising interest rates. This lowers consumption and investment, shifting the AD curve leftward.
3. The new intersection of AD (shifted left) and SRAS will be to the left of LRAS. This creates a recessionary gap, with lower real output and a lower price level than the initial full-employment equilibrium.
4. Evaluating options: Only option B matches these outcomes: recessionary gap, lower price level, lower real output.

Answer:

B. The economy will be in a recessionary gap; the price level and the real output level will decrease.