Choose the correct option from given belowa)Non-tax revenues of the government are non-recurring in nature.b)Borrowings from rest of the world are revenue receipts.c)During inflationary gap, government prepares deficit budget.d)Recovery of loans from rest of the world is revenue receipt.Correct answer is option 'C'. Can you explain this answer?

Question

Answer

Deficit Budget during Inflationary Gap

In macroeconomics, an inflationary gap is a situation when the actual output exceeds the potential output of an economy. This situation leads to an increase in the general price level of goods and services, resulting in inflation.

During an inflationary gap, the government prepares a deficit budget to control the inflationary pressures in the economy. The following points explain why the government prepares a deficit budget during an inflationary gap.

1. Increase in Government Spending: During an inflationary gap, the government increases its spending to boost economic growth. This increase in government spending leads to an increase in the aggregate demand for goods and services, which further pushes up the prices.

2. Decrease in Taxation: To stimulate economic growth, the government also reduces taxes during an inflationary gap. This reduction in taxes increases the purchasing power of people, leading to an increase in demand for goods and services. This further fuels inflation.

3. Crowding-out Effect: To finance the increased government spending, the government borrows from the market, leading to a decrease in the availability of credit for the private sector. This leads to a crowding-out effect, where private investment is reduced, and the inflationary pressures in the economy continue to rise.

4. Deficit Budget: To control the inflationary pressures, the government prepares a deficit budget during an inflationary gap. A deficit budget implies that the government's expenditure exceeds its revenue. This leads to a decrease in the aggregate demand for goods and services, which helps to bring down the prices.

Conclusion

To conclude, during an inflationary gap, the government prepares a deficit budget to control the inflationary pressures in the economy. A deficit budget leads to a decrease in the aggregate demand for goods and services, which helps to bring down the prices.

Answer

During inflationary gap there is excess demand in the economy. So, a deficit budget is prepared.

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