Contractionary policy amplifies output changes below PPC with high inflation

Steps:

• Raising interest rates reduces aggregate demand by discouraging borrowing and investment.
• This shifts the actual output point inward on the PPC diagram, altering the economy's position.
• Below the PPC indicates excess capacity and unemployment, where AD changes fully impact output due to sticky prices.
• High inflation prompts stronger rate hikes, maximizing the AD contraction and thus the shift in position.

Why C is correct:

• Below PPC with high inflation allows the policy's full output effect via the Keynesian multiplier, as slack ensures AD reductions translate directly to lower production without immediate price adjustments.

Why the others are wrong:

• A: Duplicated with C; assumes identical but question specifies C as optimal for impact.
• B: On PPC with low inflation limits output impact, as vertical AS curve directs effects more to prices than production.
• D: On PPC with low inflation yields minimal position change, as low inflation reduces policy aggressiveness.

Final answer: C