Question

Explain how fiscal policy measures can be used to reduce excess demand in an economy.

Answer 1

Fiscal policy measures can be used to reduce excess demand in an economy are:

1) Government expenditure: A cut in expenditure acts like a withdrawal from the circular flow of income of the economy. It is required to correct excess demand.

2) Taxes: Government increases taxes in order to correct a situation of inflationary gap or excess demand.

3) Public borrowing: Borrowing from the public by the government is increased in the situation of excess demand.

4) Borrowing from RBI: Borrowing from RBI is increased to fight inflationary gap.