Question

What are 1) an inflationary gap and 2) a recessionary gap?

What are the meanings of inflation and deflation and how are they affected by aggregate demand and aggregate supply?

Define aggregate supply and aggregate demand.

What is the difference in appreciation of the dollar and inflation?

Answer 1

1.

The inflationary gap arises, when actual output is greater than the potential output. So for closing the gap, government need to use contractionary fiscal policy, therefore either decreases the government spending or increase tax. Hence the budget deficit will decreases.

2.

When potential real GDP is greater than the actual real GDP, then this gap is known as a recessionary gap.

This recessionary gap can be filled by increasing AD and AD can be increased by expansionary fiscal policy and it includes either increase in the government spending or cut in the taxes.

3.

When there is an increase in the overall price level of goods and services in the economy, it is known as the inflation.

When there is an excess demand, then it leads to inflation.

When there is a decrease in the overall price level in the economy, it is known as the deflation.

When there is an excess supply, then it leads to deflation.

4.

Since aggregate demand= consumption+ investment+ government expenditure+ export- import

It means aggregate demand is the sum of all demand for goods and services by the people and firms.

Aggregate supply is defined as the sum of supply of goods and services by all firms.

5.

Since when there is appreciation of any domestic currency, then the domestic currency can buy more of foreign currency with the same domestic currency and it means domestic currency has got strength against the foreign currency. Hence it can be said that when there is an appreciation of dollar, then it means it can buy more currency compare to previous appreciation. So in case of appreciation of dollar, the relative value of dollar compare to other currency increases.

When there is an increase in the overall price level goods and services in the economy, it is known as the inflation. So in case of inflation nominal value of goods and services increases.