Question

Draw and label one or two separate AD- As models to show recessionary and inflationary gaps (5%). Then discuss how keynesians recommend each of reccessionary and inflationary gaps be closed to return economy to full employments (10%).

Answer 1

Inflationary gap can be reduced by utilizing monetary strategy &/ or fiscal policy tools. Under the monetary policy, supply of money is diminished &/or rates of interest are increased. This gap, however, can be diminished either by lessening money income thru reduction in governmental spending , or by augmenting output of commodities, or by raising taxes.

Keynes argued at time of Great depression (1930s) that unemployment was the outcome of deficiency of AD. He recommended a demand management strategy (like, increase in governmental expenditure, reduction in taxation, etc.,) to eliminate the recessionary gap.