Question

equilibrium levels;                       full employment levels of aggregate;

Y=1250                                       C= 1380

C=1100                                       S=220

S=150                                        AE=1530

1) Calculate the value of the recessionary gap (in 3 different way)

2) Draw the Keynesian Income Expenditure diagram showing all the equilibrium and full employment values, as well as
three distinct areas displaying the recessionary gap.
3) Outline three fiscal policies to close the recessionary gap. could you please show all
your work, and indicate the impact of each policy on the government budget Econ

Answer 1

1. At full employment equilibrium level : AE = Y =1530

But economy is at under full employment level i.e AE = C + I = 1100 + 150 = 1250 ( at equilibrium S = I)

Recessionary gap = AD < AS at full employment level = AD at full employment - AD at under full employment level = 1530 - 1250 = 280

2.

ADo is the planned aggregate Expenditure curve ,

Y is the aggregate supply or income curve

E is the full employment equilibrium as ADo and Y are equal here.

When aggregate Expenditure falls from ADo to AD1, there is recessionary gap as shown in the diagram.

E' is the underfull employment equilibrium.

3. Fiscal policy is a budgetary policy of the government order policy related to revenue and expenditure of the government with a view to correct the situation of excess demand and deficient demand in the economy.

The three fiscal policy measures to correct recessionary gap in the economy are:

1. Taxes :

A compulsory payment to be made to government by whom on it is imposed is referred as tax. To control recessionary gap,

the government should not impose new taxes and reduce the rate of existing taxes.

It will increase the disposable income.

Consumption by household sector and investment by producer sector will rise.

Aggregate expenditure will increase and recessionary gap is corrected.

Impact of this policy on government budget: as tax is the main source of revenue for the government, this will bring deficit in the government budget ( revenue deficit).

2. Public debt or borrowing

It refers to borrowing by government by issuing certain securities. To correct recessionary gap:

The government should decrease public debt or borrowing. Also government may offer to buy the issued securities.

It will increase the disposable income.

Consumption by household sector and investment by producer sector will rise.

Aggregate demand will increase and the situation will be corrected.

3. Fiscal measures related to governments expenditure or government spending

It refers to government expenditure on education health administration defence etc. To control recessionary gap:

the government should increase its expenditure on developmental and productive works.

It will increase the supply of money in the economy.

It will increase the level of aggregate demand in the economy.

It will help to correct recessionary pressure in the economy.