If the government and central bank had not intervened in the economy in the wake of...

If the government and central bank had not intervened in the economy in the wake of the recent financial crisis, the:
a. drop in consumption and investment would have reduced aggregate demand causing deflation

b. drop in consumption and investment would have reduced aggregate demand causing inflation

c. increase in consumption and investment would have increased aggregate supply causing disinflation

d. increase in consumption and investment would have increased aggregate demand causing inflation

Expert Solution

In the present question the correct answer is:

(a) drop in consumption and investment would have reduced aggregate demand causing deflation.

deflation happens when the price level goes below average I.e there is decrease in the average price level. Deflation usually happens when there is great fall in the aggregate demand. When the rate of inflation goes in negative, even below zero that is called as deflation.

When there is a decrease in the supply of money and the money circulation goes down, it leads to deflation. A credit bubble and financial crisis which leads to the decrease in aggregate demand, as in such situations, people tend to save more money, the circulation of money goes down which leads to deflation.

One thought that could be given is that deflation is good as decrease in prices means that the purchasing power of the consumer from his income has been increased. However if the deflation has occurred due to economic crisis or recession leading to decrease in consumption and investment leading to deflation than in such cases the results are very catastrophic and unhealthy for an economy.

Hence the correct answer is (a).

Rahul Sunny answered 2 years ago

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