Question

QUESTION FOUR [20]

4.1 Examine which phase of the business cycle is linked to a contraction in gross domestic product. Use a diagram to motivate your answer. (9)

4.2 Three consecutive contractions in gross domestic product implies the onset of recession for an economy. Compile a fiscal policy to take an economy out of this undesirable situation. (11)

Answer 1

4.1

The time period between Peak and Trough characterized by decline or contraction in GDP. This is called the Contraction Phase. Below figure shows four different phases of Business Cycle: Expansion, Peak, Contraction, Trough.

GDP starts declining after the Peak ends and the Contraction phase begins.

4.2

It is true that Three consecutive contractions in gross domestic product implies the onset of recession. Under the recession, there is sluggish growth with almost no productive activities. This situation creates huge recessionary gap with lack of aggregate demand. GDP declines to a very low level and there is immediate help needed to revive the economy.

The government in this case should EXPANSIONARY FISCAL POLICY at massive scale. It should start spending country's infrastructure and give relief packages to the needy ones. Such high spending boost consumer confidence about the future prospects and thus leads to rise in consumption expenditure and aggregate demand.