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The economy has considerable excess capacity. Would an increase in government spending likely cause inflation? Explain.

The economy has considerable excess capacity. Would an increase in government spending likely cause inflation? Explain.

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Answer #1

No, inflation is caused in a situation were the excess demand is not met by the equal supply of goods. IF the government uses an expansionary fiscal policy it will cause the demand to increase as the people with extra income in their hand will demand more and as the firms have excess capacity i.e. the ability to produce more without increasing input the extra demand will be met with increased supply without increasing the price. It will not cause any inflation. If the demand is not met with extra supply it will lead to inflation which is not the case here.

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