Question

For the purpose of restoring equilibrium in an economy currently operating at over full employment, what should be done?

• A. Taxes must be reduced
• B. Repo rate must be reduced
• C. Government expenditure must be reduced
• D. Securities must be purchased by the central bank

Answer 1

The Correct Option is C

In an economy operating at over full employment equilibrium, inflationary pressures build up due to excessive demand. To reduce demand and restore equilibrium, the government can reduce its expenditure, which would lead to a contraction in aggregate demand and help control inflation. Reducing taxes or lowering interest rates would only increase demand further, exacerbating the problem.

Answer 2

In an economy operating at over full employment equilibrium, inflationary pressures begin to build up because of excessive demand. When demand exceeds the economy's productive capacity, prices rise, leading to inflation.

To restore equilibrium and reduce inflationary pressures, the government can reduce its expenditure. This action will lead to a contraction in aggregate demand, effectively cooling down the economy and helping to control inflation.

It is important to note that reducing taxes or lowering interest rates would have the opposite effect. These actions would increase demand further, worsening the inflationary problem. With more disposable income and cheaper borrowing costs, consumption and investment would rise, thus pushing prices even higher.

Therefore, to tackle inflation in such a scenario, a reduction in government expenditure is a more effective tool for controlling demand and restoring balance in the economy.