Q. Which of the following statements about a deflationary gap is/are correct?
1.A deflationary gap is a situation where the aggregate demand is less than the aggregate supply at the full employment level of output.
2.In an economy with a deflationary gap, there is likely to be high unemployment due to insufficient demand.
3.The Keynesian multiplier effect can help to close a deflationary gap through increased government spending.
Which of the statements given above are correct?
Answer: D
Notes:
Explanation:
- Statement 1: A deflationary gap (or recessionary gap) exists when the aggregate demand is not sufficient to absorb the full employment level of output, meaning there is excess capacity and a lack of demand.
- Statement 2: Since aggregate demand is low, firms produce less, leading to a surplus of labor and thus higher unemployment.
- Statement 3: According to Keynesian economics, an increase in government spending (or a reduction in taxes) can boost aggregate demand. This initial injection of spending is amplified by the multiplier effect, which can help to increase overall economic activity and move the economy back towards the full employment level, thereby closing the deflationary gap.
