Sia
Question
Microeconomics
Posted 9 months ago
The economy of Isengard is experiencing high inflation and a rate of unemployment below the natural rate.
Which of the following combination of fiscal and monetary policy actions would be the most appropriate response to this output gap?
Choose 1 answer:
(A) Decrease government spending; decrease the money supply
(B) Decrease taxes; increase the money supply
(C) Buy bonds; decrease the reserve ratio
(D) Increase taxes; buy bonds
(ㄷ) Increase government spending; decrease taxes
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Answer from Sia
Posted 9 months ago
Solution
a
Definition of Output Gap: An output gap occurs when the actual output of an economy deviates from its potential output. In this case, Isengard is experiencing high inflation and unemployment below the natural rate, indicating an inflationary gap
b
Fiscal Policy: To address high inflation, the government should implement contractionary fiscal policy, which involves increasing taxes or decreasing government spending
c
Monetary Policy: To reduce inflation, the central bank should implement contractionary monetary policy, which involves decreasing the money supply by selling bonds or increasing the reserve ratio
d
Appropriate Combination: The most appropriate combination of fiscal and monetary policy actions to address the inflationary gap in Isengard is to increase taxes and buy bonds
Answer
(D) Increase taxes; buy bonds
Key Concept
Contractionary fiscal and monetary policies are used to reduce inflation.
Explanation
Increasing taxes reduces aggregate demand, while buying bonds decreases the money supply, both of which help to lower inflation.
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