Question

Which fiscal measure is to be adopted in correcting inflationary gap?

• A. Reduction in public expenditure
• B. Tax increase
• C. Increase in public debts
• D. All of these

Hint:

To fight an inflationary gap (overheating), the government uses fiscal policy to "cool down" the economy. This means the government spends less, taxes more, and borrows more from the public to reduce overall spending power.

Answer 1

The Correct Option is D

An inflationary gap occurs when aggregate demand exceeds aggregate supply at the full employment level, leading to rising prices (inflation). To correct this, the government uses contractionary fiscal policy to reduce aggregate demand. The measures include:

(A) Reduction in public expenditure: The government cuts its own spending on things like infrastructure and public services, which directly reduces a component of aggregate demand.
(B) Tax increase: Raising taxes on individuals and corporations reduces their disposable income and profits, leading to lower consumption and investment spending.
(C) Increase in public debts (by borrowing from public): When the government borrows money from the public (e.g., by selling bonds), it effectively removes purchasing power from the hands of the people, reducing private consumption and investment.
All these measures are designed to curb total spending in the economy.