Question

For the purpose of restoring equilibrium in an economy currently operating at over full employment, what should be done?

• A. Taxes must be reduced
• B. Repo rate must be reduced
• C. Government expenditure must be reduced
• D. Securities must be purchased by the central bank

Answer 1

The Correct Option is C

To restore equilibrium in an economy exceeding its full employment capacity, it's necessary to curb the excess demand driving inflation. A key strategy is reducing government spending. The rationale is as follows:

1. Operating beyond full employment signifies the economy is producing unsustainably, resulting in demand-pull inflation.
2. Counteracting this requires the government to enact contractionary fiscal policies to lower aggregate demand.
3. A reduction in government expenditure directly diminishes aggregate demand, which helps mitigate inflationary pressures and return the economy to its potential output.
4. This adjustment promotes efficient resource allocation without inflationary consequences, thereby restoring economic equilibrium.

Consequently, decreasing government expenditure is the prescribed measure for stabilizing an economy experiencing over full employment.