State and discuss the components of Aggregate Demand in a two-sector economy.

OR

In the given figure, what does the gap ‘KT’ represent? State any two fiscal measures to correct the situation.

For Blind Candidates :

What is meant by the deflationary gap? State any two fiscal measures to correct the situation of the deflationary gap.

Aggregate demand is the total of Expenditure that the people plan to incur on the purchase of different goods and services produced in an economy during one accounting year, corresponding to the different levels of income.

In a two-sector economy, the components of aggregate demand will be the following:

a. Private consumption demand- Private consumption demand is the total expenditure that all the households in an economy are willing to incur on the purchase of different goods and services for their own consumption in a given frame of time. Consumption is based on many factors such as the price of the good, income level, price of related goods, etc. This is mainly determined by the disposable income of the household.

b. Private investment demand- Private investment demand means the addition to the capital stock or the expenditure incurred by the private investors during a given frame of time to create new capital Assets of a country such as plants or machinery. The demand for investment depends upon the marginal efficiency of capital and the rate of interest.

OR

In the given figure the gap KT represents the deflationary gap. We can assess change this by observing that equilibrium is attained at less than full employment level.

The two fiscal measures which can be used to correct this situation are -

a. Reduction in taxes- When there is deficient demand, the government can reduce the rate of different taxes and can even eliminate some of them. It will increase the purchasing power of the people. Now they will have more disposable income, which can be used to spend on consumption or investment. This will increase the level of aggregate demand. This is also called the revenue policy,

b. Increase in public expenditure- the government can invest in Public Work such as constructing roads, flyover, buildings, etc. This will provide more income to the people which can be used for consumption and investment. This will increase the level of aggregate demand.