Question

The economy of Palestine is suffering from recession, use the suitable economic policy to correct this situation.

Explain briefly & Graph your answer using AD & AS model.

Answer 1

As economy of Palestine is suffering from recession, actual output of economy must be less than potential output which will result in creating recessionary gap in the economy. Economy must be at level A.

To reduce recessionary gap, government of Palestine should adopt expansionary fiscal or expansionary monetary policy whose motive is to raise aggregate demand. Expansionary fiscal policy will raise government spending and reduce tax such that people have more money to spend on goods and services which will raise aggregate demand in the economy. Expansionary monetary policy will raise supply of money which will give more money in customers hands which will raise aggregate demand. Both of these factors will shift demand to new demand which will raise price level from P to P1 while output level rises from Y to Y1. It will reduce recessionary gap and take economy to its potential level.