Answer to Question #44874 in Macroeconomics for Alishia

Question

illustrate and explain the demand management policies government can implement to close the inflationary gap in the economy?

Answer 1

An inflationary gap arises in the Keynesian model of the macroeconomy when the equilibrium level of aggregate production exceeds what could be produced at full employment. This represents the condition that arises when the economy is in a business-cycle expansion.

Contractionary fiscal policy is a decrease in government spending and/or an increase in taxes designed to avoid or correct the inflationary problems associated with a business-cycle expansion. Either action causes a decrease or downward shift of the aggregate expenditures line. If the correct vertical shift is achieved, then the Keynesian model can achieve equilibrium at the $9 trillion full-employment level of aggregate production. Such a result would close the inflationary gap and reduce the rate of inflation.