Question 1

Arrange the following in the correct sequential order, if the government of a nation is trying to curtail the situation of inflationary gap : (i) Decrease in disposable income (ii) Increase in taxes (iii) Decrease in Aggregate Demand

Accepted Answer

(C) (ii), (iii), (i)

Question 2

'India has been dealing with the problem of Deficient Demand, since the imposition of Covid lockdown in March 2020'. State and discuss any two monetary policy measures to combat the situation of Deficient Demand in India.

Accepted Answer

**Two monetary policy measures to combat deficient demand:**

1. **Decrease in Bank Rate:** The Central Bank can reduce the bank rate, which is the rate at which it lends to commercial banks. A lower bank rate reduces the cost of borrowing for commercial banks, enabling them to lend at lower rates. This encourages borrowing and investment, increasing aggregate demand.

2. **Open Market Operations (Purchase of Securities):** The Central Bank can purchase government securities from the open market. This injects money into the economy, increasing the reserves of commercial banks and their capacity to create credit. Higher credit availability boosts consumption and investment expenditure, correcting deficient demand.

Question 3

'Keynes suggested the use of various tools to deal with the situation of Inflationary Gap prevailing in an economy. State and discuss any two monetary policy measures to combat the situation of Inflationary gap in a hypothetical economy.

Accepted Answer

**Two monetary policy measures to combat inflationary gap:**

1. **Increase in Bank Rate:** The Central Bank increases the bank rate, raising the cost of borrowing from the central bank. Commercial banks pass this on to borrowers by increasing lending rates. Higher interest rates discourage borrowing for consumption and investment, reducing aggregate demand and controlling inflation.

2. **Increase in Legal Reserve Ratio (CRR/SLR):** Increasing CRR or SLR reduces the reserves available with commercial banks for lending. This directly limits credit creation capacity, reducing money supply and aggregate demand in the economy, helping to correct the inflationary gap.

Question 4

Define Inflationary Gap. State, how the government can control the situation of inflationary gap, using the taxation policy.

Accepted Answer

**Inflationary Gap** is the excess of actual aggregate demand over the aggregate demand required to establish full employment equilibrium. It arises when AD > AS at full employment level, leading to rise in general price level.

**Government can control inflationary gap using taxation policy by:**
- **Increasing direct taxes** (income tax, corporate tax) reduces disposable income of households and profits of firms, leading to reduced consumption and investment expenditure
- **Increasing indirect taxes** (GST, excise duty) raises prices of goods, discouraging consumption
- Both measures reduce aggregate demand, helping to close the inflationary gap

Question 5

Arrange the following in the correct sequential order, if the government of a nation is trying to curtail the situation of inflationary gap : (i) Decrease in disposable income (ii) Increase in taxes (iii) Decrease in Aggregate Demand Alternatives :

Accepted Answer

(C) (ii), (iii), (i)

Class 12 Macro Economics: Excess Demand and Deficient Demand

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