Final answer:
Unemployment compensation acts as an automatic stabilizer by increasing when unemployment rises during economic downturns, and decreasing as more people find work during expansions, which moderates economic fluctuations.
Step-by-step explanation:
Unemployment compensation is an example of an automatic stabilizer in the economy because it helps to moderate the fluctuations in the economic cycle. Specifically, the correct answer to the student's question is B. an automatic stabilizer because it falls as income increases, slowing an economic expansion. This is because when the economy is expanding and more people are employed, income levels rise, resulting in fewer people needing unemployment benefits. Conversely, during an economic downturn, when income falls and unemployment rates increase, the need for and disbursement of unemployment compensation rise, helping to cushion the impact of the recession on households.
Automatic stabilizers, like unemployment compensation, do not offset all the shifts in aggregate demand, but they can significantly reduce the impact of economic fluctuation. These stabilizers function quickly and automatically without the need for new government action, which makes them useful for addressing cyclical unemployment during economic contractions. While they're not a complete solution to economic volatility, they do provide some relief by partially offsetting changes in the level of output.