Question

Describe the impact of inflationary and recessionary gaps and the lump sum tax on the domestic economy.

Answer 1

Recessionary gap is a situation when the potential GDP is more than the actual GDP in the economy. It happens when the economy approaches recession which mean that the aggregate output is less than the output which economy can produce if they operate at full potential level. The diagram is given below:Inflationary gap is a situation when the GDP exceeds the potential GDP by some amount. It causes the prices rises too much that it raises the demand in the economy which is more than the potential level. The diagram is given above:

Lump sum tax is implied on per good produced on the producer. It raises the average fixed cost and does not have any effect on average variable cost thereby raising total cost which shifts the aggregate supply in the economy to the left which raises the price level in the economy and shifts the quantity produced in the economy backwards.