Question

1. What is the difference between an inflationary gap and a recessionary gap? How do they relate to GDP, income and employment?
2. Discuss three items that would cause the investment demand curve to increase. Provide a real world examples of each one (not from the textbook)

Answer 1

Inflationary Gap occurs when aggregate demand is greater than the aggregate supply prevailing at the full employment level. Higher demand puts upward pressure on the price level. it is called an inflationary gap. There is no rise in real income. There will be a rise in price only. There would not be a positive effect on the output either.

On the other side, there is a situation where aggregate demand is less than the aggregate supply of full employment level. Or equilibrium is set at a lower level. thus price falls. it is called the deflationary gap. real income falls.

determinants of the investment demand curve:

• The interest rate plays a more critical role in determining the investment demand. A fall in the interest rate causes a rise in investment demand.
• Profit expectation also determines the investment demand curve. For example, during the economic recession, government makes huge expenditure to spur up demand. Thus, rise in demand leads to the rise in the profit expectations, so investors make more investments.
• Technological development also affects investment positively. Development IT technology has led to massive investment in IT sector.